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Stable deal TCV to allay concerns on near-term growth

* TCS reported revenue of USD6.87b in 2QFY23, up 4.0% QoQ in constant currency (CC) terms, 50bp above our estimates. The company reported deal wins of USD8.1b (up 7% YoY/flat QoQ, book-to-bill ratio at 1.2x), in line with     its historical trajectory

* EBIT improved 90bp QoQ to 24% (vs. our estimate of 23.5%) despite supply pressures. Lower employee expenses, operating leverage, and lower subcontractor expenses aided margins in 2QFY23. LTM attrition jumped 180bp to21.5%. The management has indicated that quarterly annualized attrition should moderate starting 3QFY23.

* Management commentary on the demand environment and deal pipeline remained intact with no visible impact of weakening macro environment; however, the management has indicated risks to deal pipeline and conversion in Europe due to uncertainty around energy prices. TCS is seeing some caution for longer term deals and is experiencing some delayed decision making in Europe, but it continues to see a strong spending environment in the US While the optimistic commentary was on expected lines, we remain concerned on the near-term growth due to macro slowdown. We are factoring in USD revenue growth of 7.5% YoY in FY23, owing to the macro headwinds in the    second half of the year along with elevated cross-currency headwinds. 

 * The margin (up 90bp QoQ) was better than expected on account of lower employee costs, sub-contractor expenses, and operating leverage. The management indicated that attrition has peaked out and quarterly attrition shoul ease in the coming quarters. The supply situation easing out in 2HFY23 along with benefits from increased fresher additions in the last few quarters and lower sub-contractor costs should aid margins. However, we remain concerned about Q3 margin due to the timelines of cost optimization strategies. We expect the margin to improve in 2HFY23 and hit exit run-rate of ~25%. We expect FY23/24 margin to be at 24.1/24.8%.

 * We have slightly tweaked our FY23/FY24 EPS. We expect a USD revenue CAGR of 8.1% over FY22-24 and INR EPS CAGR of 13% during the same period (aided by INR depreciation). Our TP of INR3,580 implies 27x FY24E EPS, with a 15% upside potential. We reiterate our Buy rating on the stock

 * Good topline growth, margin improvement led by lower employee cost

Revenue (CC) grew 4.0% QoQ, INR EBIT/ PAT rose 11%/8% YoY in 2QFY23.

EBIT margin of 24% (up 90bps QoQ) was above our estimate of 23.5%, led by lower employee costs

The company added 9.8k associates, the lowest net adds in the last nine quarters.

TCS announced a dividend of INR8/share. 

Key highlights from the management commentary

TCS is not witnessing any budget cuts or a deferment in client spends, although some European clients have expressed concerns on the macro demand.

There could be some deal softening in Europe, but the US should remain strong for the company

It is exhibiting some caution on its long-term projects. Clients are building various economic models with some downside due to macro-economic concerns and the company is also experiencing delays in decision-making in some, smaller pockets.

With hiring slowing down in the technology sector and salary expectations moderating, supply side issues should ease off in 2HFY23.

LTM attrition in IT services was at 21.5% in Q2. The management suggested that attrition has peaked and expects quarterly attrition to moderate in the coming quarters.

Valuation and view

Increase in interest rates, slow economic growth, and elevated geo-political tensions have adversely impacted the macro environment and raised concerns over IT spends.

Given TCS’s size, order book, and exposure to long duration orders, and portfolio, it is well positioned to withstand the weakening macro environment and ride on the anticipated industry growth.

Owing to its steadfast market leadership position and best-in-class execution, the company has been able to maintain its industry-leading margin and demonstrate superior return ratios.

We maintain our positive stance on TCS. Our TP of INR3,580 implies 27x FY24E EPS, with a 15% upside potential. We reiterate our Buy rating.

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