* Revenues performance inline, margins below estimates:
For the quarter TCS has delivered a inline revenue performance, while operating margins missed the mark. Topline up by 3.1% on reported basis to $4591 mn, led by 3.5% volume growth and cross currency tailwinds of 1.1%, on a constant currency basis growth was at 2% QoQ. EBIT margins for the quarter declined by 230BPS QoQ to 23.4%, the fall was attributed to wage hike (150BPS impact) and INR appreciation (80BPS). Net income for the quarter was down by 10% QoQ to Rs5945 crore, the fall was also partly attributed to lower other income down 5.8% QoQ, on account of lower forex gains.
* Digital remains strong, BFSI and retail continue to witness stress:
Starting from Q1FY2018, TCS reclassified the industry vertical’s reporting structure to give a better view on annuity-based revenue and project-centric volatile revenue under regional markets and others. Under the new structure, both troubled verticals, BFSI and retail showed 2% odd growth on a QoQ basis, while other verticals delivered higher than the company’s average growth. The regional market and others witnessed a 3.6% QoQ fall, which can be attributed to weakness in Japan business and Diligenta. The digital segment continued to show strong growth, up by 7.6% QoQ and 26% YoY, contributing 18.9% to revenue. In terms of geographies, Europe led the pack with 5.9% QoQ growth, North America increased by 1.7% QoQ and Latin America reported 2.8% QoQ growth. During the quarter, TCS had 11 large deal wins across the vertical, primarily led by North America. Management indicates a decent pipeline in the non-BFSI space in North America for FY2018.
* Demand visibility remains elusive, margins under pressure:
Given the uncertainties in two of the company’s largest verticals – BFSI (33%) and retail (12%) – and lack of visibility in regional markets’ revenue segment (India, Diligenta, Japan and Middle East), demand visibility seems elusive. Further, industry-level transition to digital (deals getting smaller and increasing competition) and pricing pressure in legacy services are making it difficult to gauge the demand trajectory. The only solace is revenue from the digital segment, which is growing at a much faster pace but is still not big enough to move the needle materially. Further, strong rupee and higher cost of doing business in the US (increasing local hiring) will continue to restrict margins in FY2018, though lower wage hike coupled with automation and lesser supply-side pressure will mitigate part of the margin pressure in FY2019E.
Maintain Hold with a price target of Rs 2,450: We have tweaked our estimates for FY18/19E on account of INR currency reset to Rs64.5. Given the uncertainties in the demand environment owing to industry transition phase, regulatory overhang in US and modest earnings growth over FY17-19E (4.8% CAGR), Hence we do not see any positive triggers to upgrade in our rating or price target. Nevertheless, company’s policy of strong excess cash payout and increasing FCF yield will support valuation multiple limiting major downside, as street is already factoring a weak FY2018E. We maintain our Hold rating on the stock with an unchanged price target (PT) of Rs2,450
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