TCS’ Q4FY18 operating performance beat expectations on all counts. USD revenue growth came in at 3.9% q-o-q. The growth was driven by E&U and Digital. Margin expanded by 20 bps to 25.4% – in line with the expectation.
Trajectory changing course: TCS reported double-digit USD revenue growth (last seen in Q4FY15) on 7.6% y-o-y growth in CC terms. We expect strong deal wins even in an ailing vertical like Retail and bottoming out of challenges in BFS/NA to drive high single digit revenue growth in CC terms in FY19. Moreover, we believe, challenges due to pricing pressure and deal ramp-ups will be offset by stronger revenue growth, operational efficiency, better revenue-mix, and INR depreciation. We expect mid-teen earnings CAGR over FY18-20e. Reiterate Buy.
Growth trajectory set to improve
Revenue trajectory continues to improve after bottoming out in Q1FY18. The management remained non-committal on returning to double-digit revenue growth in CC terms. TCS delivered high single digit to double digit revenue growth across the verticals excluding BFSI (32% of rev: 3.2% y-o-y CC terms), retail (12% of rev: 1.5% y-o-y) and Regional Market (18% of rev: 4% y-o-y), indicating the challenges remain concentrated in select few verticals and not across.
We believe the strong deal wins, waning challenges in Retail (driven by optimism around deal ramp-ups), and improving outlook in BFS/NA will drive steady improvement in revenue trajectory.
BFSI (32% of revenue) – outlook getting better
According to the management, growth trajectory for BFSI vertical would improve from Q1FY19. The confidence was driven by discussion with clients, deal pipeline, and stabilisation with large accounts. Moreover, the growth in BFS/EMEA continues to be strong. We believe turnaround in BFS/NA will drive high single digit (every percent point acceleration in revenue growth would add 30 bps to revenue growth) revenue growth in the vertical in FY19-20e in CC terms. Hence, revenue acceleration by 3-4 ppt in FY19-20e could add 1-1.5 ppt to revenue acceleration.
Margin concern remains, but INR depreciation could cushion impact
Deal closure over past few months have been strong for TCS. The over-arching concern about the ramp-ups driving the margin lower is overdone. The management alluded that the new deals have been structured in a manner to have a limited impact on the margin. Moreover, we believe, acceleration in revenue growth, better business mix (stronger digital revenue growth), and INR depreciation will soften the impact on pricing pressure, onsite investment, and initial impact of knowledge transfer.
Digital (22% of revenue) – gaining prominence
Momentum in Digital continues to be strong. According to the management, the depth of Digital engagement will drive revenue growth in CY18/19, whereas in CY16/17 width of Digital adoption helped drive revenue growth. The company is already witnessing improving deal size in Digital (large deal of $50 million+ signed).
No change in tax rate — does it elude BEAT concern?
Our key concern in the previous quarter was around tax reform in the US that could impact the margin and tax rate of the company. According to the management, the tax rate would remain largely at 24-25% range. The impact of BEAT is likely to be higher in FY20 as compared to FY19.
(i) Recommended 1:1 bonus share issue,
(ii ) added $1.5 bn in incremental revenue during the year and crossed $19 bn mark in FY18, (iii) client addition strong with
1 client added in $100 mn, 3 clients added in $50 mn, 4 clients in $20 mn revenue bands, (iv) provides Cloud services to 200+ clients, (v) machine first delivery model saw strong adoption in IT ops and process automation (20+ clients in Q4) powered by Ignio and third party solutions, (vi) total nos. of clients under Ignio is +50, (vii) TCS Bancs recorded 29 new wins and 25 go-lives in FY18, (viii) 74% of incremental revenue came from Digital services and (ix) 247k employees Digital trained and 208k Agile trained.
Raise FY19/20 estimates
We revise our USD revenue estimate for FY19/20e by 2.4/2.5%, while retaining margin expectation in line with the management’s guidance. Our FY19/20e EPS estimate stand revised up by 2.2/2.3%. We have assumed INR/USD rate of Rs 66.3 for FY19/20e.
Valuations: Revise multiple to 20x
TCS reported improving revenue growth trajectory across the verticals with signs of sustainable turnaround in Retail and BFSI. We see stronger Digital growth and bottoming out of challenges in the legacy business to drive improving revenue trajectory for FY19/20e. We expect 10.5% revenue CAGR in USD term over FY17-20e. Expect FY18-20e Ebitda margin at 25-26% with EPS Rs 159/180.5 in FY19/FY20e.
On better revenue visibility driven by turnaround in key verticals and improving earnings trajectory, we revise our target multiple to 20x from 18x earlier. Our TP stands at Rs 3,610 (20x FY20E), implying 13% upside from CMP of Rs 3,191. At CMP, stock trades at 20x/18x FY19E/ FY20E EPS.