TP up to Rs 2,500; Q4FY20 is expected to be soft; ‘Buy’ retained as company is likely to outperform peers in medium term
TCS’ Q3 revenue growth of 0.3% q-o-q/6.8% y-o-y cc missed our estimate but Ebit margin of 25% surprised positively, expanding 100bps q-o-q helped by ccy and better utilisation. Deal TCV of $6 bn was reasonable given it excluded the large Phoenix deal. However, management indicated continued softness at least in Q4 as issues in banking & retail clients in North America continue. We maintain Buy as we expect TCS to outperform peers on growth & margin in medium term.
Slight miss in revenue, but large margin beat: TCS’ revenue growth at 0.3% q-o-q cc/6.8% y-o-y cc missed even our muted estimate of 0.7% as growth was tepid in North America due to weakness in BFSI & retail, further hurt by higher than expected furloughs in a seasonally weak quarter. Ebit margin at 25% surprised positively though vs. our expectation of 24.3%, expanding 100bps q-o-q. Higher utilisation, better cost control and ccy aided margin improvement. Lower other income led to miss in PBT though this was partly offset by lower tax rate. The company also announced a dividend of Rs 5 per share.
Near-term outlook remains cautious: TCS reported deal TCV of $6 bn in the quarter, up only 2% y-o-y – however, this does not include the large Phoenix deal reported in mid November. Management continued to guide for softness in the near-term though it remains hopeful of acceleration in the medium term.
Key takeaways from earnings call: (i) Within BFSI (5.3% y-o-y cc, -0.7% q-o-q), management indicated strength in insurance and Europe & Australia but weakness in North America and UK; (ii) management attributed weakness in retail (5.1% y-o-y cc, 4% q-o-q) mainly to issues with a few large North American accounts even as the vertical has done well in Europe & UK; (iii) strength in life sciences & healthcare (17.1% y-o-y cc, 3.8% q-o-q) was attributed to a number of large transformational deals; (iv) communications & media vertical continued to grow well (+9.5% y-o-y cc, 1.3% q-o-q); (v) on 2020 client budgets, management said that it was too early to call out but early indications appear to be mixed.
Maintain Buy: We tweak our FY20-22e estimates mainly to reflect better margin. Our price target increases to Rs 2,500 (prev. Rs 2,300) based on 23x 12m forward EPS as of Jan-21. Despite near-term headwinds, we maintain Buy.