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TCS Q3 Review: Deal Wins, Revenue Growth Offset Margin Miss, Say Analysts

Here's what brokerages made of TCS' Q3 performance:

<div class="paragraphs"><p>Rajesh Gopinathan, chief executive officer and managing director of Tata Consultancy Services. (Photographer: Dhiraj Singh/Bloomberg)</p></div>
Rajesh Gopinathan, chief executive officer and managing director of Tata Consultancy Services. (Photographer: Dhiraj Singh/Bloomberg)

Shares of Tata Consultancy Services Ltd. ended higher as analysts expect it to sustain its revenue growth trajectory, helped by healthy deal wins and demand for digital technologies, even as margin pressure and attrition risks persist.

India’s largest software services exporter saw its revenue rise sequentially, in line with estimates, in the quarter ended December. The company retained its double-digit growth guidance for the ongoing fiscal.

It won new deals worth $7.6 billion during the period, taking the total deals to $23.3 billion in the first nine months of FY22.

Key Highlights (QoQ)

  • Net profit rose 1.51% to Rs 9,769 crore compared with the forecast of Rs 9,988 crore.

  • Operating profit rose 1.98% to Rs 12,237 crore.

  • During the quarter, the company added 10 $100-million clients, taking the total count of such customers to 58.

  • Attrition inched up to 15.3% compared to 11.9% in the second quarter.

  • Declared a third interim dividend of Rs 7 per share.

Opinion
TCS Q3 Results: Revenue In Line With Estimates, Attrition Inches Up

Samir Seksaria, chief financial officer, at TCS, termed the attrition scenario as a “challenging supply environment” and said the company exercised various operating levers in Q3 to mitigate higher costs and manage employee expenses.

The IT company also added 28,238 people to its workforce in the quarter.

TCS also approved a Rs 18,000-crore buyback. The company will repurchase 4 crore shares, or 1.08% of the total paid-up equity, at Rs 4,500 apiece. That’s a 16.58% premium to Wednesday’s closing price.

Shares of the company gained as much as 2.2% to Rs 3,944.4 apiece before ending 1% higher on Thursday. Of the 50 analysts tracking the IT company, 30 recommend a ‘buy’, 12 suggest a ‘hold’ and eight have a ‘sell’ rating, according to Bloomberg data. The average of 12-month price targets implies an upside of 7.9%.

Here's what brokerages made of TCS' Q3 performance:

Morgan Stanley

  • Maintains 'overweight' with a target price at Rs 4,400 apiece, implying a potential upside of 14%.

  • Revenue growth surprise after a gap of two quarters should drive some optimism toward the stock. Sees room for valuation to move up.

  • Constant currency revenue growth of 4% quarter-on-quarter was not only better than its estimate but also ahead of the higher end of the street expectations.

  • Across major regions, management commentary on growth trends was quite comforting.

  • A sharp rise in attrition and continued increase in subcontractor costs remain areas of concern. However, as per management, quarterly annualized attrition rates have stabilized and employee churn was down this quarter sequentially.

  • Despite margin disappointment, EPS estimates are still moving up marginally (1-2%), led by better revenues.

  • A material earnings upgrade may not happen yet, we see room for the multiple gap vs. Accenture, led by continued optimism about revenue growth.

IDBI Capital

  • Downgrades stock to 'hold' from 'buy, target price at Rs 4,250, implying a potential upside of 10%.

  • Current run-up in price factors in most of the positives.

  • EBIT margin stood at 25% below its estimate of 26.1% mainly due to higher employee, travel and facility cost.

  • Revenue growth was broad-based driven by double-digit growth across geographies and verticals.

  • TCS will be a key beneficiary of robust growth in digital technologies. Coupled with improving margins, high return ratios and healthy capital allocation are long-term positives for the stock.

Emkay Financial

  • Maintains 'buy' with a target price of Rs 4,150, implying a potential upside of 7.5%.

  • Strong and sustained demand environment, broad-based growth, healthy deal intake and traction in cloud, internet of things and digital engineering give management confidence to sustain a robust revenue growth trajectory.

  • EBIT margin declined by 60 basis points quarter-on-quarter to 25% due to an increase in compensation costs, higher subcontracting expenses and discretionary non-manpower costs.

  • Management indicated that the deal intake remained well balanced across deal sizes in Q3, with the strongest deal pipeline.

  • Management remains confident of delivering double-digit revenue growth in FY22, considering healthy deal wins/deal pipeline and broad-based growth.

Opinion
At TCS, Over 2 Lakh Women Employees; Attrition Rises, Hiring Expands

HDFC Securities

  • Maintains ‘add’ with a target price of Rs 4,400, implying a potential upside of 14%.

  • TCS reported in-line revenue performance, while the margin was a miss.

  • Expects TCS’ growth to be steady, supported by healthy demand environment, owing to cloud adoption; growth opportunity for Horizon-2 services, which includes AI/analytics and security; improvement in client addition; and better alignment with fast-growing hyperscaler ecosystem.

  • The ongoing supply-side issues (attrition increased to 15.3%, yet industry-best) and return of discretionary spend will limit margin expansion, despite the advantages of operating leverage and better pricing.

  • Reskilling/training, promotions, and fresher hiring will help tide attrition challenge.

Nirmal Bang

  • Cuts rating to ‘accumulate’ from ‘buy’, target price at Rs 4,169, implying a potential upside of around 8%.

  • In a seasonally weak quarter, TCS delivered better-than-expected revenue growth.

  • Double-digit growth was seen across almost all segments, driven by strong demand for digital transformation and end-to-end capabilities of TCS.

  • Stellar quarter also helped TCS to achieve the milestone of $25 billion revenue in CY21.

  • The impact on margins was largely because of an increase in subcontractor expenses.

  • To retain the in-house talent, the company has handed out 1,10,000 promotions so far this year and plans to promote additional 40,000 resources in Q4.

Prabhudas Lilladher

  • Maintains ‘buy’ with a target price of Rs 4,468, implying a potential upside of over 15%.

  • Though attrition inched up to 15.3%, it is still the lowest in the industry. The brokerage expects attrition to peak out in Q4 and slowly inch down in coming quarters.

  • TCS can easily sustain about 26% EBIT margin in FY23 despite return of discretionary expenses and supply-side cost pressures. As supply-side pressures ease off in FY23, there is scope for margin expansion led by reducing subcontracting costs, improved pricing, pyramid optimization, best-in-class supply side engine and leverage from revenue growth.

Motilal Oswal

  • Maintains ‘buy’ with a target price of Rs 4,250, implying a potential upside of 10%.

  • Healthy top line beat to assuage growth concern; outlook strong.

  • Encouraged by the company’s robust top line growth in a seasonally weaker quarter. “We expect this performance to alleviate the concerns on its growth potential and the likely drag from growing share of smaller deals in the market.”

  • IT services has entered into a technology upcycle, with cloud migration and digital transformation-led deals coming into the market.

  • Given TCS’ size, capabilities, and portfolio stretch, it is rightly positioned to leverage the anticipated industry growth.

  • TCS has consistently maintained its market leadership position and shown best in-class execution. This renders the company with ample room to maintain its industry-leading margin and demonstrate the superior return ratios.

Investec

  • Maintains ‘sell’ but raises target price to Rs 3,445 from Rs 3,385, still implying a potential downside of 8.7%.

  • It’s the second-quarter of margin miss for TCS.

  • TCS had executed two large deals in Q4 of the prior year. The underlying expectation was of a potential headwind to revenue led by productivity benefits from these large deals. TCS expects the current revenue momentum to continue into Q4 with no meaningful impact from these deals.

  • With increased fresher hiring ramping up, subcontractor expenses could trend downwards and serve as a margin tailwind as travel costs increase.

Kotak Institutional Equities

  • Maintains ‘add’, sees fair value at Rs 4,350, a potential upside of 12.7%.

  • The company will be at the forefront of driving digital transformation for clients as it is better positioned than peers to manage margin headwinds.

  • Expects CY2022 to be another robust year of growth for IT services led by accelerated transformation and cloud opportunities.

  • Focus on the experience layer will continue, however we expect organizations to also increase spending on data and core modernization 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 positions 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.

Dolat Capital

  • Maintains ‘reduce’ rating with target price of Rs 3,910, implying a potential upside of 1%.

  • Given sustained stance (qualitative) and commentary on multi-year transformation, and improved growth performance in Q3, Dolat Capital sees a modest uptick in our growth estimates for both FY23/24E by 2%/2.4%.

  • Slightly upgrades EBIT margin estimates, given slower than anticipated resumption of discretionary costs.

  • Believes TCS and other Tier I IT companies would continue to deliver strong revenue momentum over next 4-6 quarters.

Jefferies

  • Maintains ‘hold’ rating, raises target price to Rs 4,180 from Rs 4,100, implying a potential upside of 8.3%.

  • Despite high attrition, TCS has managed employee costs well. Over FY22-24, we expect TCS to deliver 11% profit CAGR.

  • While the buyback at 17% premium to market price may be a near term catalyst, its rich multiples offer limited scope for rerating relative to its growth.

  • Despite the positive surprise on revenues, TCS' Q3 results offer limited scope for earnings upgrades due to the margin disappointment.

  • TCS' 9% price-to-earnings ratio premium for 4% lower earnings growth vs Infosys should limit further re-rating.