TCS Rating: Add- Growth was strong across segments in Q3FY22

Firm in a position to make most of opportunities in sector; FY22-24e EPS up 1-3%; TP raised to Rs 4,350; ‘Add’ rating maintained

In any case, the current wave of spending driven by cloud and digital transformation, is a multi-year opportunity.
In any case, the current wave of spending driven by cloud and digital transformation, is a multi-year opportunity.

TCS reported solid revenue growth of 4% q-o-q, ahead of our estimate of 2.6%, led by strong demand across business segments. The company will be at the forefront of driving digital transformation for clients as it is better positioned than peers to manage margin headwinds. We raise FY2022-24e EPS by 1-3% and Fair Value to Rs 4,350 valuing the stock at 32X FY2024e EPS (September 2023e EPS earlier). Maintain Add rating.

Solid quarter with broad-based growth; Ebit margin decline on costs to backfill attrition: TCS reported c/c revenue growth of 4% q-o-q and 15.4% y-o-y. In reported terms, revenues grew 3% to $6.5 bn. Revenue growth was broad-based with all verticals growing above 15% (excluding volatile regional markets) in c/c on y-o-y comparison. Even on a sequential basis, all verticals grew well. Ebit margin of 25% (-60 bps q-o-q, -160 bps y-o-y) was lower than our estimate of 25.4%. Headwinds for the quarter on q-o-q basis included (i) 70 bps from backfilling of attrition, compensation increases and subcon costs and (ii) 60 bps from increase in discretionary costs, higher travel and marketing and facilities costs. This was offset by 60 bps from pyramid balancing, higher utilisation, slight uptick in realisation and 10 bps from Rupee depreciation. Net profit of Rs 97.7 bn grew 1.5% q-o-q and 12.3% y-o-y.

Muted TCV but growth prospects are reasonably good: TCV of $7.6 bn grew 11.7% y-o-y and was flattish on a sequential basis. TCV trends are modest, though we understand that ACV is reasonably strong. In any case, the current wave of spending driven by cloud and digital transformation, is a multi-year opportunity.

Horizon 2 and 3 are bigger opportunities than cloud migration (horizon 1). Movement to cloud is triggering tremendous innovation and is leading to pick-up in horizon 2 (cloud native application development) and horizon 3 (integrating with ecosystem partners) initiatives. Full service model, strong competencies across a range of digital and cloud technologies and strong client relationships position TCS well to participate across the entire length of the opportunity.

Raise FY2022-24 revenue and EPS estimates by 1-3%: We expect CY2022 to be another robust year of growth for IT services led by accelerated transformation and cloud opportunities. Focus on experience layer will continue; however we expect organisations to also increase spending on data and core modernisation initiatives to leverage the full benefit of cloud investments. This creates a plethora of opportunities with deals of all sizes. The runway for growth is reasonably long with potential for double-digit growth till FY2024e. Early investments, breadth of capabilities and contextual understanding of client systems position TCS well to make the most of opportunities. TCS has better-than-peers supply-side management, which will allow it to grow profitably. It trades at multiples that are higher than historical levels but justified by higher growth. We maintain Add.

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