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TCS/INFO FY22 AR analysis: Focus on Cloud to continue

Structural tailwinds intact; margins stable

* Analysis of the FY22 annual reports of TCS and INFO suggested continued multiyear Digital and Cloud transformation initiatives, along with the need to drive organizational efficiencies.

* Key spending areas include Cloud adoption, cyber security, 5G, network virtualization, data analytics, customer experience, hyper personalization, and supply chain transformation.

* Emerging technologies like IoT, metaverse, and blockchain are also gaining traction.  Though companies in the IT Services space remain cautious about the macro environment (on high inflation, geopolitical tensions, and a slowdown in growth), demand remains robust.

Focus on ESG continues

* TCS has set forth its new carbon reduction goal to reduce its absolute greenhouse gas emissions by 70% by CY25 (with CY16 as the base year), and to achieve net zero emissions by CY30. The new goal comes in the backdrop of having achieved its previous target of reducing its specific carbon footprint by half ahead of schedule by FY20 (v/s baseline year FY08).

* TCS plans to improve its energy efficiency, reduce the power requirements of its IT systems, and use renewable sources and carbon removal offsets to cut its carbon footprint.

* In FY22, INFO met 53.8% of its electricity consumption needs in India through renewable sources. Infosys Foundation USA has reached over 23m students and 1m teachers. It saw 1.8m registrations in Infosys springboard India.

* ESG remains a key focus area for both TCS and INFO, with incremental progress made in FY22.

Talent remains the key focus area

* With rising demand, attracting talent, training, and retention gained paramount importance. Both TCS and INFO hired in record numbers in FY22 (TCS/INFO: 104k/54k employees).

* The companies have taken various measures such as offering competitive compensation, improving employee engagement, employee wellbeing, reskilling, and providing better opportunities to acquire and retain talent.

* Though attrition remained elevated, companies are seeing some moderation in attrition on a quarterly annualized basis.

Margin to remain resilient despite headwinds

* TCS maintains its long-term aspirational margin band at 26-28% as it does not see any change in its long-term cost structure or relative competitiveness. Higher-quality revenue is aiding margin resilience in TCS.

* INFO delivered a margin of 23% on the back of strong growth, despite margin pressures in FY22.

* With attrition moderating, an improvement in pricing, lower dependency on sub-contractors, higher fresher additions, and strong operating leverage, both companies should be able to sustain margins going forward.

Strong operating metrics; payouts remain strong

* Balance Sheets for both companies remains strong and liquid (with cash at 21- 34% of assets and ~4% of market capitalization).

* Sub-optimal assets like goodwill/intangibles remained low for TCS and INFO (2- 10.5% of net worth).

* RoE of TCS (~44%) and INFO (~29%) remained the best across the industry.

* OCF/EBITA conversion (TCS/INFO – 75%/79%) and FCF/PAT conversion (TCS/INFO – 96%/103%) remained healthy.

* Both companies reported strong payouts in FY22 (TCS/INFO – 97%/75%).

Valuation and view

*  Given the capabilities of TCS and INFO, both companies are in good position to withstand a weakening macro environment. Margin should remain stable, despite the headwinds, on account of moderation in attrition, strong fresher addition, and a positive pricing environment.

* We remain positive on the IT Services sector on reasonable valuations and good double-digit earnings growth (partially aided by a 300-350bp impact from the depreciation in the INR v/s the USD) in FY23.

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