A Cut Above, But Way To Go!

TCS 

A CUT ABOVE, BUT WAY TO GO! 

Tata group’s cash cow and one of the largest Indian company, Tata Consultancy Services (TCS), has shown steady rise in the span of last 10 years, barring several bumps following the slump in Sensex and Nifty. The stock was trailing the benchmark indices in 2017. However, the stock began gaining traction this year with over 12 per cent return in the last one month. The company ended fiscal 2018 on a positive note, beating street estimates in the March quarter and soaring to its all-time high. Read on to find out what lies ahead for the company. 

Company Overview: 

TCS, a subsidiary of the Tata Group, is India’s largest IT service provider. The company has over 394,000 consultants spread across 46 countries. The company generates revenue from various verticals such as banking, financial services & insurance (BFSI); manufacturing segment; retail and consumer business; communication, media and technology (CMT) and others. BFSI dominated TCS revenue with around 39 per cent in FY18. Other verticals such as retail and CMT contributed around 17 per cent each to the total revenue of the company.TCS has successfully sailed through various technological transformations during the last five decades of its existence. TCS is firmly placed above the big IT services providers in India such as Infosys, Wipro, HCL Technologies and Tech Mahindra not only in terms of revenues but also by market capitalisation. TCS is the largest company by market capitalisation in the country with a market cap of over Rs 6 lakh crore. It is also placed among the most valuable IT services brand in the world. Its brand value has grown 14 per cent from $9 billion in 2017, placing it among the top three IT services companies globally. The brand value of IBM and Accenture stood at $20 billion and $17 billion, respectively. When it comes to revenue generation, TCS alone generates around 70 per cent of total funds for its parent company. 

IT sector outlook: 

The IT sector remained a laggard for most part of 2017 and before. However, the sector outperformed both the benchmark indices, Sensex and Nifty, at a time when they were going through a phase of correction. The BSE IT index is up about 12 per cent, as against one per cent rise in Sensex on a YTD basis. The rising number and size of digital deals, recovery of spends in BFSI, retail and utilities verticals, which contribute nearly 53 per cent to Indian IT services’ revenues, augurs well for the sector. The nagging question of the H1-B work visas issued by the US, where the observers constantly watched the alternating trend of tightening and loosening of the visa regime, is much less a factor now than before. Indian IT is now said to be much less dependent on these visas. 

The current deal momentum in the industry led by the digital is believed to be the highest as compared to the last several years. The significant deal flows have been led by sharp recovery in spends by brick-and-mortar retailers, IoT wave in manufacturing and bounceback in the capex cycle of the energy sector. With robust cash flow generation and limited possibility of large acquisitions or setting up of huge campuses or delivery centres, higher dividend distribution to the shareholders becomes an imperative. 

An added tailwind for the sector that has resulted in this positive reaction is that USD/INR has crossed the Rs 66-mark. We expect this to aid in sustaining margin, if not aid margin expansion. Also, the management commentaries of most of the companies have indicated that FY19 is well-placed in terms of growth vis-à-vis FY18, fuelling the positive sentiment in the IT stocks. 

Positive Quarter 

In an estimate defying Q4 FY18, the company reported consolidated revenue of Rs 32,075 crore, registering an increase of 3.79 per cent QoQ. Notably, TCS’ revenue from the digital space increased 42.8 per cent YoY, accounting for 23.8 per cent of the total revenue. The company's EBITDA for the quarter rose by 4.4 per cent QoQ to Rs 8,652 crore, with corresponding margin expansion of 16 bps. Its EBITDA margin for the quarter stood at 26.97 per cent. The PAT for the quarter came in at Rs 6,925 crore, witnessing an increase of 5.81 per cent QoQ. Industry-wise, the management is confident about the retail business vertical gaining momentum in the rest of the fiscal. 

The company's six industry verticals grew faster than the company average on a year-on-year scale. The only business segment that is lagging is the banking and financial services (BFS) vertical. The management said it is incrementally turning confident about the BFS vertical, though revenues are yet to reflect this. Growth in this segment remained flat or expanded just 0.4 per cent on a sequential basis in constant currency terms. More clarity is expected in the June quarterly results. TCS also reduced attrition rate by 10 basis points to 11 per cent in the quarter, with the total headcount reaching 394,998 with net addition of 4,118 employees over the quarter. 

On an annual basis, the company’s revenue in FY18 increased by 4.4 per cent to Rs 1,23,104 crore, while EBITDA remained flat at Rs 32,516 crore. Further, the company reported net profit of Rs 25,880 crore, down by 2 per cent YoY. 

Renewed traction in UK and Europe On a YoY basis, the company’s business in continental Europe grew 19.1 per cent, in UK it grew 10.7 per cent, in Asia-Pacific it grew 8.6 per cent and in North America it grew 4.9 per cent. The company expects strong growth momentum to continue in the UK and Europe. 

TCS vs Infosys 

As anticipated, TCS not only staged a better performance in the March quarter, but also pipped Infosys to the post by reporting faster dollardenominated revenue growth for FY18 after lagging in the previous two years.In addition, TCS retained the margin band of 26-28 per cent for FY19, while Infosys lowered it to 22-24 per cent from 23-25 per cent. TCS also fared well on the client additions on a YoY basis in the March quarter. It added 16 clients with more than 50 million dollar of billing each, including three with more than $100-million billing each. In comparison, Infosys reported six new clients with more than $50-million of billing each, including one client above $100-million billing. 

For shareholders, a positive factor was that both the companies showed greater interest in improving returns on their investments. Infosys declared special dividend over and above the usual annual dividend and also proposed to return cash in the near term. On the other hand, TCS announced one bonus share for one held, apart from declaring dividend. The operating margin is one of the most important metrics for IT firms. Over the last year, TCS has pipped Infosys on the margin front in all but one quarter. This quarter was no different. On the valuation front, the company maintained a PE ratio of 23.60x as against its peers Infosys (15.59x) and Wipro (15.62x). The company’s return on equity (RoE) and return on capital employed (RoCE) stood at 32.80 per cent and 78.35 per cent, respectively. The company has a good RoE track record with three-year RoE of 36.45 per cent. The company is virtually debt-free. TCS has also been maintaining a healthy dividend payout of 47.30 per cent. 

Conclusion: 

On the back of healthy deal wins and deal closures in the recent past (which cumulatively stands at around US $8.3 billion in total contract value); traction for its digital offerings and anticipation of cross-currency tailwinds, the TCS management remains optimistic on double-digit revenue growth in FY19. But for the stock to deliver good returns, its BFS vertical has to revive. Traction in this segment may well be crucial for the earnings upgrades, a necessity for the next leg of growth in the stock. We believe TCS has a noticeable distance to cover on the growth metrics, which will prove decisive for the stock going forward. We urge our reader-investors to HOLD the scrip.