Our meeting with TCS suggests banking/financials will show a soft Q1, as large deals have been held off. At the same time, potential closure of a large deal in insurance in the Q2 should help tide over H2 weak seasonality. Most other verticals are strong except retail, which remains volatile. Target Ebit margin band remains stable at 26-28% with recent organisation restructuring underlining digital focus. Stock could see near term pressure on this commentary. BFS off to a slow start, retail volatile, other verticals healthy: TCS expects banking/financials (c28% of revenue) to show a soft Q1 vs earlier expectations of acceleration, as US based clients in the vertical hold off large deals. Smaller size projects continue to come through. Company believes that this could improve from Q217 onwards, on the back of regulatory changes towards a more benign environment and increase in interest rates. Retail (c13% of revenues) will likely remain volatile as that industry continues to see the transition from conventional to online retailing. Most other major verticals — communications, manufacturing, life sciences, hi-tech, energy/utilities, travel/hospitality— will continue to show good momentum in H118.
Insurance to kick in H218, likely to help tide over weak seasonality: In contrast to the commentary on banking/financials, TCS is seeing strong traction in Insurance vertical, c12% of revenues. This is on the back of good business on services and Diligenta. Company is expecting closure of a large deal in the vertical in Q2, the ramp-up of which can help tide over the weak seasonality of H2. In the backdrop of the commentary, we believe that H2 growth will now be critical for TCS to show an growth acceleration in FY18E vs FY17; FY17 USD revenue growth was +6.2% y-o-y, we are projecting +8.7% y-o-y in FY18E.
Target margin band maintained at 26-28% Ebit: The company reiterated its target margin band of 26-28% in constant currency terms. While a stronger Rupee, visa costs and wage hike are headwinds in the Q1, company believes that it has adequate levers on utilisations and automation to maintain this band. Visa applications this year are same as last year. We are projecting Ebit margin of 25.6% in FY18E. TCS’ wage hikes this year have been the highest among peer group and this could be calibrated and used as a lever in the future.
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Organisation restructuring to align better to digital transition: TCS has recently formed a business unit to consolidate the new service practices , digital related, into a single unit reporting to one business head. These are — Digital transformation comprising automation, analytics, IoT, cyber security, cloud apps etc.; Cognitive business including business process and infra services; Consulting and integration. TCS believes that could significantly increase the effectiveness addressing the opportunity in technology. We believe this at least underlines TCS’ focus on its digital practice and efforts to capture the opportunity and gain scale.
Our view — near term pressure but structurally well positioned: Given sector high valuations for the company at 17x/15x of FY18/19E EPS, the commentary would surely be a near term dampener given previous comments of receding headwinds and positive sentiment heading into the year. Beyond this, TCS remains the best positioned within Indian IT in digital with robust execution and client metrics. Maintain Buy although we continue to prefer Infosys (also rated Buy) vs TCS at these levels.