40bp margin expansion q-o-q a surprise; FY22e growth raised to c14%; TP up to Rs 3,200; Hold retained given limited upside
TCS is the largest and, we think, one of the best managed IT companies in India; we continue to see it participating in the high tide of IT spend.
TCS reported a robust quarter with 4.1% q-o-q cc growth vs 2.5% consensus expectations. A surprise was the 40bp margin expansion q-o-q to 26.6% Ebit margin, despite a wage hike in the quarter. Mgmt is confident in the demand environment and affirmed double-digit growth in FY22e. It does not believe there was any budget flush in Q3, and, hence, thinks the strength seen in Q3 should continue in Q4. We were already expecting 12% growth in FY22e, but the Q3 beat makes us raise our growth estimate to c14%. We expect a return to 8-9% growth in FY23e/24e.
In our view, pandemic-led needs have resulted in an improved outlook for Indian IT over the next 3-4 years, as most customers have accelerated modernising plans. We continue to expect mega transformational deals as clients transfer end to end operations to IT companies. We expect cloud adoption to remain the key underlying tech trend and the key monitorable data in 2021.
Q3FY21 highlights: Margins expanded in Q3 despite a wage hike impact of 160bp q-o-q. Offshoring, in our view, helped contain employee costs (up only 1.7% q-o-q), despite a +3% increase in headcount, 100% variable pay-outs and the wage hike. Higher utilisation, record low attrition and favourable currency also contributed to the margin surprise.
The total contract value (TCV) of deals signed in Q3 was $6.8 bn compared to past four quarters’ average of $7.6 bn. Growth was broad-based across verticals and regions. According to TCS’s CEO, every client is being driven to spend more on technology – be it on business growth or operational cost-cutting. For banks (largest vertical), eg, tech spend will be driven by the move to cloud, wealth management investments and customer experience.
Estimates and valuation: TCS is the largest and, we think, one of the best managed IT companies in India; we continue to see it participating in the high tide of IT spend. However, considering what we view as limited upside potential for revenues, margins and valuation, we maintain our Hold, but with a higher TP of Rs 3,200 ( Rs 3,050), largely driven by EPS upgrades. The stock trades at 30x/28x on FY22e/23e EPS. We are assuming a 100bp decline in FY22e over Q3FY21 margins, led by normalisation of travel, visas, and other costs.