Buy rating on TCS; High Expectations

By: | Updated: March 14, 2016 1:19 AM

Overall revenue growth should improve in FY17e

Our meeting with the company suggests some growth headwinds in FY15-16 are now past with a likely revival ahead. Overall revenue growth should improve in FY17e, also built into our forecasts. Expectations which have reset are benign going into the seasonally strong first half. Despite the string of misses in recent quarters, EPS downgrades on TCS have been inline with sector peers, with profit growth being among best in the sector. Maintain Buy.

Some past headwinds are now behind, some still remain

Major headwinds for TCS’ growth in FY15/16e have been insurance, telecom and energy among the verticals, and Europe, UK and Japan among the geographies. Of these, insurance (part of the 41% revenue exposure to BFSI) is likely to see a revival in FY17e with the major culprit, Diligenta, likely to bottom out over the next two quarters.

Telecom (8.4% of revenue) and energy (4.1% of revenue) are likely to continue growing below company average but should have a lesser overall impact due to the smaller exposure. Europe (11% of revenue) had seen a temporary slowdown which should likely revive while UK (16% of revenue) ex-Diligenta should continue to grow. Visibility in Japan continues to remain low.

Growth likely to improve from here on, next year budgets do not indicate any specific cause for worry
TCS’ revenue growth in reported USD terms has declined from 15% in FY15 to 7% in FY16e. A part of it can be attributed to the base effect of the cross currency impact in Q4FY15 (-240bps), overhang of which should not be there in FY17e. Company believes that some headwinds discussed earlier are now past and growth should improve from here on. This is also reflected in our 10%/12.4% y-o-y growth projections of USD revenues in FY17/18e. In the March 16 quarter, sequential growth could likely be similar to that in the previous years.

Tying in with CTSH commentary…..

Cognizant had indicated a push-out in discretionary projects within the banking and financial services vertical as one of the key reasons for its muted guidance for the first quarter. TCS has a 40% exposure to the vertical and with most of the budgeting exercise for the year largely complete, it does not see any specific risks within the vertical. In fact, growth for the vertical is likely to remain resilient as it has in recent past on back of (i) Discretionary spend on digital; (ii) Regulatory and risk management; (iii) Simplification of legacy systems.
….and NASSCOM guidance

Unlike Infosys, TCS is not benchmarking its own growth to NASSCOM guidance (10-12% y-o-y) for FY17e. We believe that in comparison to the same time last year, TCS growth projections are far more conservative now vs NASSCOM. We are projecting a 10% y-o-y growth in FY17e for TCS, at the low end of NASSCOM guidance.

Stable growth and lowest earnings volatility

TCS’ focus on driving growth is based on two strategies (i) Improving client metrics with an equal focus on hunting (new logo addition) and mining (increasing business from existing logos); (ii) Sustaining profitability in incremental revenue addition. Through FY15 and 9MFY16, TCS’ margins have been relatively resilient within large cap companies (on a higher base), with the best profit growth trajectory. This has also resulted in the lowest earnings volatility vs peers. In fact over the past year, TCS’ FY16e EPS downgrade has not been higher than sector peers.
Expectations benign, maintain Buy.

TCS is trading at 17.5x 12M forward consensus P/E, well below the 5-year average. Given the valuations and growth projections, expectations are benign especially going into the seasonally strong first half. Risk reward remain favourable, maintain Buy.


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