Key highlights of our recent interaction with Tata Consultancy Services’ (TCS) management are: (i) sustained softness in BFSI and retail stemming from lower discretionary spending by large banks and online transition by large retailers, respectively; and (ii) strong growth in rest of business (RoB) spearheaded by broad-based spending. We believe, given substantial contribution of BFSI and retail segments (32.9% & 12.2%) to TCS’ revenue, overall growth in Q2FY18 is likely to remain subdued. Moreover, by virtue of traditionally being a first half revenue-driven company, overall FY18 growth too is likely to be muted. The anticipated soft revenue coupled with rupee strengthening is likely to lead to muted earnings growth in spite of strong execution and offerings. Maintain Hold with target price of Rs 2,315.
Tepid BFSI & retail to steal rest of business’ strong show
Management expects BFSI and retail, which contribute 32.9% and 12.2%, respectively, to TCS’ revenue, to continue to be soft in an otherwise seasonally strong quarter. While it attributed the softness in BFSI to absence of pick-up in discretionary spending by large banks, retail weakness has been due to transition to online channels by large retailers. A weak Q2FY18 (seasonally strong quarter) will imply muted growth in FY18 as well as TCS’ growth has traditionally been led by H1. Management expects strong growth in RoB led by digital and other services. While the above is a concern for TCS in the near term, it also implies muted growth for the entire sector as BFSI and retail segments contribute >50% to Indian IT industry’s revenue.
Outlook and valuations: Key segments tepid; maintain ‘HOLD’
The absence of pick-up in spending in BFSI is surprising given the rise in interest rates in the North American market and improving profits, particularly in the BFSI space. Stagnant new spends imply further delay in decision making and awarding of new deals. We believe, this coupled with continued pain in retail (although temporary) implies lower growth for the sector and in particular for TCS, Infosys and Wipro, which draw substantial portion of revenue from these segments. We will keenly monitor quarterly earnings & commentary and maintain that TCS is a dividend play until margin stabilises and demand environment improves in spite of its best-in-class execution. We maintain ‘HOLD/SP’ with target price of Rs 2,315 (16x FY19e EPS). The stock is currently trading at 18.7x and 17.3x FY18e and FY19e EPS.
As India’s largest and most-experienced IT services firm, TCS is well-positioned to benefit from the growing demand for offshore IT services. It is a serious contender for winning large deals, as it has more experience than peers in implementing large, complex, and mission critical projects. End-to-end full services offerings, traction in emerging markets, ability to roll up large acquisitions, improving sales and marketing prowess and willingness to take multiple big bets (different go-to-market models) are among the key rationales for TCS to sustain its long term hi-growth trajectory.
Key Risks to our investment theme include — (i) double dip recession in major market US and prolonged slowdown in Europe, (ii) sharp cross currency movements and appreciation of rupee against USD, Euro and GBP, (iii) pricing pressure, (iv) a reduction in margins and (v) Adverse impact of US Immigration bill.
TCS is India’s largest and one of its oldest IT companies. It commenced operations in 1968 and provides a comprehensive range of IT services to industries such as banking and financial services, insurance, manufacturing, telecommunications, retail, and transportation. With a presence in 42 countries, TCS is positioned to deliver its services seamlessly. TCS has a large diversified client base, its employee force stands at 385,809 (including subsidiaries) and its revenues for the last twelve months (TTM) stood at Rs 1,182 bn.