Published on 12/10/2018 11:07:37 AM | Source: ICICI Securities

Hold Tata Consultancy Services Ltd For Target Rs.1935.00 - ICICI Securities

TCS reported an in-line Q2FY19 with revenue growth in constant currency (CC) terms being 3.7% QoQ (I-Sec: 4% QoQ) and EBIT margin expanding by 150bps QoQ to 26.5% (I-Sec: 26.5%). Revenue growth was 11.5% YoY in CC terms with the management expecting YoY revenue growth in CC terms to sustain in double-digits in H2FY19. Revenue growth, as expected, was driven by the BFSI and Retail/CPG verticals (3.5% and 3.4% QoQ respectively in CC terms) with continued ramp-up of platform deals helping growth in “Regional Markets & Others” (7.3% QoQ in CC terms).

TCS is seeing strong resonance from clients for its transformational offerings like location agnostic agile and Machine First Delivery Model (MFDM). Management is seeing a structural uptick in the BFSI vertical in North America though commentary on Retail/CPG vertical was more guarded with macro driven client specific issues still within a realm of possibility (though management is seeing no such issues on the ground as of now).

Deal TCV was $4.9bn in the quarter, flattish QoQ, implying a book-to-bill ratio of just 0.94x. However, we see limited revenue signalling from the deal TCV as digital deals would increasingly form a higher proportion of the book which given their quicker revenue conversion can still drive revenue growth inline with expectations despite book-to-bill ratio being <1x. Also, backlog should be stronger, given that most of large platform centric deals were signed in H2FY18, which will fully ramp-up only in H2FY19.

Higher fresher hiring plans of 28,000 for FY20 vs 20,000 fresher offers for FY19, when attrition is largely benign, is also an indicator of management’s higher confidence in the demand environment. We reiterate HOLD rating on TCS with a revised target price of Rs1935 as we lower the target multiple to 20x (from 21x earlier) given higher macroeconomic uncertainty. Constant currency margin expansion of 30bps QoQ was also modestly lower than our expectations.

* BFSI, Retail/CPG and platform deals drive growth; Communications and E&U take a pause post strong growth in Q1. Revenue growth in Q2FY19 was driven by the BFSI, Retail/CPG and Life-sciences/Healthcare verticals which reported QoQ growth in CC terms of 3.5%, 3.4% and 5.7% respectively. “Regional Markets & Others” also posted strong growth of 7.3% QoQ in CC terms driven by the continued ramp-up of platform centric deals in the insurance segment. Management believes that the BFSI vertical is seeing a structural turnaround (6.1% YoY growth in CC terms) with growth being broad-based across geographies as well as across banking and insurance sub-segments. However, commentary was more guarded on the Retail/CPG vertical with occasional one-off client bankruptcies still possible though there is no evidence of any client specific issues on the ground as of today. Automotive is the only vertical where the company is seeing weak near-term demand trends. Quarterly volatility is expected to manifest more in verticals like Communications and Technology though both the verticals present significant opportunities over the medium term. Revenues were flattish in communications on a QoQ basis (CC terms) though still up 8% on a YoY basis. Likewise E&U revenues were also flattish QoQ though YoY growth was very strong at 22.2% in CC terms.

* Maintain HOLD; premium multiple a function of strong cash generation, efficient capital allocation and superior revenue predictability. Revenue story for TCS seems to be tracking broadly in-line with expectations with the company expecting a double-digit YoY exit in CC terms in Q4FY19 which should set the base for a healthy FY20 as well. Headcount addition was healthy in Q2FY19 at 10,227 and at a 12 quarter high (partly driven by rebadging from clients) and TCS is likely to extend offers to 28,000 fresher’s for the next fiscal, which is also indicative of its confidence in continuity of demand. With commentary on large markets and segments like North America and BFSI unilaterally constructive, we model USD revenue growth of 9.4% for FY19 (10.5% in CC terms) and 8.8% for FY20. However, we modestly tweak our margin assumption lower to 26.7% from 27% earlier. TCS is trading at 21.3x FY20E EPS which though somewhat rich for a ~10% revenue growth story with limited operating leverage has to be seen in the context of its strong cash generation (FCF/NI of ~93% in FY18 and 92.5% in H1FY19) and superior capital allocation where the company intends to return 80 to 100% of its FCF generation back to shareholders over a period of time. Superior predictability of growth also feeds into a higher multiple for TCS. Maintain HOLD with a target price of Rs1,935.


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