Missing revenue traction weighs on profitability too
* Growth missing large-segment traction: TCS’ 6.3% YoY CC growth in 1QFY18 was marginally below our estimate of 6.9%. YoY CC growth in larger revenue contributors remained soft – BFSI (5%), Retail (-3%), North America (3.5%) and the UK (6%). This, in our view, implies elevated challenges to exceed 8% YoY CC growth of FY17 in this fiscal. We estimate 7.5% CC growth in FY18.
* Farthest from aspired margin band (ex-currency):While the margin pressures from wage hikes and currency were known, TCS’ 240bp QoQ EBIT margin contraction (to 23.4% v/s estimate 24.3%) in 1QFY18 implied very limited results from any offsetting levers. While TCS retained its confidence of operating in the 26-28% EBIT margin band ex-currency, 1Q margin adjusted for currencies was ~24.5%, the farthest from the band in recent history. This drives additional 40bp cut in our EBIT margin estimate for FY18 to 24.8%. 1QFY18 PAT declined 10% QoQ to INR59.45b, below our estimate of INR62b, mainly led by miss on the operating performance.
* BFS and Retail continue to drag: TCS won four large deals in BFSI in 1QFY18 out of 11 in total, but cited that the pipeline remains short of suggesting homogenous strength in the vertical. Client-specific concerns are driving the same. Retail grew 2% QoQ CC driven by Digital, but the segment is still under the scanner, given the structural challenges facing many retailers.
* Valuation view: Our earnings estimate for FY18 is down by 4% after factoring in the revenue and margin miss in 1QFY18. TCS trades at 16.5x FY19E for FY17-19 USD revenue/EPS CAGR of 8%/5%. Lower growth will unlikely support the premium valuation to peers, and we expect correction to the same in reaction to the results. Our price target of INR2,350 implies 4% downside. Neutral.
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