Stock corner: ‘Neutral’ on TCS, growth in Q1 came as a disappointment

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Published: July 15, 2019 3:20:58 AM

TCS moderated its commentary on growth and is now hinting at sustaining double-digit growth vs acceleration earlier. We continue to expect 9% CC revenue growth for FY20F.

Stock corner, TCS, Q1 result, GDP growth, PMI, markets news, TCS news, TCS shareTCS moderated its commentary on growth and is now hinting at sustaining double-digit growth vs acceleration earlier.

Results were below our forecast and consensus estimate on growth, but margins were in line. While the deal momentum was strong, we see risks to double-digit growth guidance for TCS on:

(i) weakening macro indicators (slowing GDP growth, PMI in UK/EU and client financials) indicating slowing momentum; (ii) softness in BFSI given a weaker spending environment (in capital markets/large EU banks)/Manufacturing (EU/UK) and base effects in regional markets (contribute 60% of revenues); and

(iii) steep asking rate of 2.5% CQGR over Q2-Q4 vs 1.7% in FY18 and 2.6% in FY19 (despite large insurance deals).

TCS moderated its commentary on growth and is now hinting at sustaining double-digit growth vs acceleration earlier. We continue to expect 9% CC revenue growth for FY20F. Margins will remain under pressure, in our view, in the absence of INR benefit, on: (i) rising onsite costs & sub-con expenses led by immigration tightening and a tight labour market in the US; (ii) limited operational levers (near peak utilisation and limited SGA); and (iii) hiring growth catching up with revenue. Given slowing growth/margins, valuation of ~23x 1-yr-fwd EPS is not justified, in our view, and we reiterate our Neutral rating.

Q1: Disappoints on growth CC growth was at 2.3%, in our view (vs Street at 3%), and Ebit margins at 24.2% (in line with Street). Positives: (i) strong deal wins of $5.7 bn in Q1 led by US/BFSI/Retail and (ii) strength in Digital at 42% y-o-y in CC and focus on products & platforms business. Negatives: (i) tempering of revenue growth outlook for FY20F and weakness in BFSI and (ii) softer growth in Retail/Telecom, though TCS expects recovery in Q2.

Estimates unchanged, raise TP to Rs 2,000 on a two-quarter roll-forward

Our estimates are largely unchanged given we were already building in slower growth at 9% y-o-y in CC for FY20F vs Street expectations of double-digit growth. We see risks to consensus growth/margins, and our Ebit margins are 50-70bp lower vs consensus over FY20-21F.

Overall, we now look for USD revenue/EPS CAGRs of 7.7%/7.4% over FY19-21F, expect Ebit margins to fall to 24% by FY22F, and expect EPS of `89.6/96.4 by FY20F/21F. Our higher TP of `2,000 continues to be based on a 20x multiple applied to 1-year-forward EPS (to Sep-21F) of `99.9. The increase in TP is driven by a two-quarter roll-forward. HCLT is our top pick in India IT. Downside risks include further growth/margin moderation.

Q1 results: Disappoints on growth TCS reported USD revenues of $5,485 mn, which grew 1.6% q-o-q vs our and consensus estimate of 2.4% and 2.6%. It reported CC revenue growth of 2.3% q-o-q (implied based on y-o-y CC revenue growth) vs our forecast and the Bloomberg consensus estimate of 2.8% and 3.0%. TCS requires steep asking rate of ~2.5% CQGR over Q2-Q4FY20F to achieve double-digit growth vs ~1.8% and 3.0% CQGR in FY18 and FY19 (supported by large insurance deals). Ebit margin was 24.2% (vs 25.7% in Q4) vs our and consensus estimates of 24.3% and 24.2%. Ebit margins was impacted by salary hikes effective 1 April and INR appreciation. Going forward TCS sees margins risks from (i) rising subcontractor costs due to the labour crunch in the US and (ii) INR appreciation.
Broad-based growth across segments

Geographies: In y-o-y CC terms, North America 7.7%, LatAm 6.4% and MEA 6.4% dragged, while UK 16%, Continental Europe 15% and India 15.9% led growth for company.

Verticals: In y-o-y CC terms, BFSI 9.2%, Retail/CPG 7.9%, Manufacturing 5.5%, Tech & Services 7.8% and Telecom & Media 8.4% dragged, while Life Sciences & Healthcare 18.1% and Regional Markets & Others 16.9% led growth.

Digital: TCS indicated digital revenues were 32.2% of revenues (vs 31% in Q4FY19) and grew 42.1% y-o-y in CC terms (vs ~46.4% in Q4FY19).

 

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