Published on 15/07/2017 10:06:28 AM | Source: Arihant Capital Markets Ltd

Neutral Tata Consultancy Services Ltd For Target Rs.2,416.00 - Arihant Capital

Strong volume growth of 3.5% qoq but a decline in earnings of 10% qoq:

TCS has delivered a strong topline performance with 3.5% qoq volume growth, driven by sustained traction in the Digital service offerings. The growth in focus geographies was encouraging across verticals with a cautiously optimistic approach towards Insurance and Retail. Focus shifted to profitability given the declining operating leverage, appreciating INR and compulsive commitments towards onsite hiring, digital skill training and sales with contextual expertise.


* Strong segmental commentary:

TCS has restructured its business in Emerging Markets (India, ME, APAC ex-Australia) that were more volatile owing to project-based nature of delivery, product-platform sales and inconsistency in business opportunities. This collective base accounts for ~17.6% of total revenues as of Q1FY18 and is termed as ‘Regional Markets & Others’. The company reported 2.3% qoq growth in BFSI, driven by a platform win in Insurance and a Core Banking win in USA. The traction in BFSI is improving and is also reflected in healthy pipeline for Diligenta business. Retail revenues grew 2% qoq and saw some very encouraging deal engagements. The remaining segments grew in the range of 4- 7% qoq and are showing sustained promise. The only dampener would be the performance of low focus ‘Regional Markets & Others’ segment.


* Operating margins:

EBIT margin at 23.4% declined ~240bps qoq, impacted by wage revision (~150bps) and adverse currency movements. Management maintains its medium term target EBIT margin range of 26-28% though outside currency fluctuations.


* Highlights of conference call:

* Management commentary was mixed on Banking and Financial Services (BFS) vertical stating that diverse spending trends across clients constrains secular visibility . While revenues from Retail rebounded with 2% qoq growth in CC terms (V/s decline of 4.4% qoq in Mar’17 quarter), the management remains cautious on its prospects given the challenges clients are facing.

* Digital business revenues accounted for ~18.9% of overall revenues (up 7.6% qoq /26% yoy in CC terms). Management indicated that Digital deal sizes are progressively increasing citing an IoT & Analytics multi-year deal worth US$50mn.

* Headcount at 3,85,809 people declined by 1414 sequentially. TCS has reported a sequential decline in headcount for the first time since Jun’09 quarter.

* Management has restructured its service practices to bring in new edge services under a new horizontal group named ‘Business and Technology Services Group (BTS)’. Within BTS, the company has 3 groups, namely (1) Digital Transformation Services Group, (2) Cognitive Business Operations and (3) Consulting & Service Systems Integration. Management believes this reorganization will enhance focus and delivery capabilities while keeping stability in other customer-facing organization.


* Outlook:

The outlook on the business growth has been largely kept intact with strong growth in Digital business and improved business metrics on the segment - size, scale, and competitiveness. Taking into account the risk to growth estimates and likely impact on profitability, we have a NETURAL rating on the stock with TP of Rs 2416 based on P/E of 16x FY19E EPS of Rs 151.

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