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.
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).