Tata Consultancy Services rating: Hold | Preparing for uncertain times

Growth beat estimates in constant currency terms; FY23-25e EPS cut by 1-3%; ‘Hold’ retained with new target price of Rs 3,070.

Tata Consultancy Services employees
Profit at Rs 95 bn, up 5% y-o-y, also missed estimates due to lower-than-expected margins.

TCS’s Q1FY23 revenues were slightly ahead but margins and profits missed estimates. Deal wins at $8.2 bn were steady reflecting healthy demand, but increasing reliance on subcontractors with lower net hiring suggests that TCS is also preparing for an uncertain macro. We lower our FY23-25 estimates by 1-3% to factor in the miss and expect TCS to deliver a 9% EPS CAGR in FY22-24. TCS’ premium valuations may limit upside. Maintain Hold and revise PT to Rs 3,070.

Q1 results miss estimates: TCS’ Q1FY23 revenues of $6.8 bn, up 3.5% q-o-q in CC terms was ahead of estimates. However, higher-than-expected cross-currency headwinds of 220bps resulted in reported $ revenues being in line with estimates. EBIT margins at 23.1%, down 190bps q-o-q, disappointed due to higher-than-expected subcontracting and travel costs. Profit at Rs 95 bn, up 5% y-o-y, also missed estimates due to lower-than-expected margins.

Growth led by key vertical and markets: Revenue growth during Q1 was driven by continued recovery in Retail (+7.0% q-o-q cc) and healthy growth in BFSI (+4.0% q-o-q cc) and Tech (+3.6% q-o-q cc). Healthy deal wins in Q4FY22 and Q1FY23 will likely keep growth strong in  BFSI vertical. Among markets, North America (+4.5% q-o-q cc), and Latin America (+4.9% q-o-q cc) drove growth. Management expects growth in North America to remain relatively stronger vs. Europe/UK.

Healthy deal wins; Fx impacting $ growth: Deal wins were well distributed across sizes and included two deals of c$400 m. TCS’ trailing 12-month book-to-bill ratio of 1.3x and healthy TCV trends across BFSI, Retail, and North America offer comfort on growth. We maintain our cc revenue growth forecasts; however, we lower our $ revenues by 1-1.4% on adverse cross-currency moves.

Margins disappoint: Margins in Q1 fell 190bps q-o-q due to wage hikes (-140bps), higher subcontracting costs (-50bps) and higher travel costs (-40bps), which were partly offset by lower other costs (+50bps). While TCS offered 5-8% wage hike, its average wage grew by 3% q-o-q, reflecting benefits of better employee pyramid. Attrition rose further to 19.7% but management expects this to moderate from H2FY23. We lower our FY23 margin estimates by 50bps and expect margin expansion only in FY25 given our expectation of growth moderation in FY24.

Maintain Hold: We lower our FY23-25 EPS by 1-3%. While TCS would be better placed in a recessionary environment, its rich valuations will likely weigh on stock performance. Maintain Hold with revised PT of Rs 3,070 based on 24x PE.

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