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Strong demand outlook to compensate for margin headwind

Record headcount addition adds to demand visibility

TCS reported a revenue of USD6.7b in 4QFY22, up 3.2%/2.6% QoQ in constant currency (CC)/USD terms, but slightly below our estimate of 3.1% QoQ growth. Revenue in 4QFY22 was driven by Retail and Manufacturing, while regional markets and others remained weak.

EBIT margin was flat QoQ at 25% in 4QFY22 (in line). Given its record high employee headcount of 35k and continued sub-contracting pressure (+5% QoQ), we view the flat margin as a positive. Net profit rose 1.6% QoQ to INR99.3b (in line).

TCS clocked record-high deal wins at USD11.3b (book-to-bill ratio at 1.7x), with two mega deals of ~USD1b each (with a tenor of seven-to-ten years). These strong deal wins suggest a robust revenue growth outlook for FY23.

The management’s commentary on the demand environment continues to remain strong. It said it is in a better place v/s 4QFY21. With a record high employee addition, higher visibility on Cloud-led spending over the next two-to-three years, and strong demand, we are factoring in a revenue growth of 13.9% YoY in CC terms in FY23.

While deal TCV in 9MFY22 was in a narrow range, a record TCV in 4Q should help ease concerns on smaller deals dominating flows in the sector. TCS has been able to tap into large transformational and platform-led opportunities, which should help position itself well in the context of its peer group in FY23.

While the management indicated a muted margin over the next few quarters, it is seeing an uptick in pricing (including COLA adjustments in existing contracts), which should help profitability recover by 2HFY23. Moreover, TCS should start seeing some benefit in overall cost in FY23 from its fresher intake of 100k in FY22. We expect margin to continue to remain under pressure and below their long-term guided range of 26-28%.

LTM attrition rose 210bp QoQ to 17.4%. The management indicated that attrition is normalizing on a quarterly annualized basis. We expect the current supply-side challenges to normalize over the next two quarters.

We have marginally (1%/2%) raised our FY23/FY24 EPS. We expect a 13.4%/ 16.5% USD revenue/INR EPS CAGR over FY22-24. Our TP of INR4,240/share, implies 30x FY24E EPS, with a 15% upside potential. We maintain our Buy rating on the stock.

Small revenue miss, but large jump in deal flow in 4QFY22

Revenue (CC) grew 3.2% QoQ, INR EBIT rose 7.6% YoY, and INR PAT increased by 7.3% YoY in 4QFY22.  In FY22, USD revenue/INR EBIT/INR PAT grew 16%/14%/18% YoY.

Revenue rose 2.6% QoQ to USD6.7b and slightly missed our estimate of 3.1% QoQ growth.

Strong growth was seen in Retail and Manufacturing, while regional markets and others dragged down growth.

EBIT margin was flat QoQ at 25% (in line).  It recorded the highest ever employee count at 35k. Sub-contracting cost rose 5% QoQ.

TCS reported a record total contract value (TCV) of USD11.3b, which increased by 49% QoQ and 23% YoY.

The company reported an LTM attrition rate of 17.4% (+210bp QoQ).

Net profit rose 1.6% QoQ of INR99.3b (in line).  Net cash from operations jumped 19% YoY to INR110.51b (i.e. 111% of net income). Free cash flow rose 27% YoY to INR102.6b (i.e. 103% of net income).

Total cash and investments stood at INR561b at the end of 4QFY22.

TCS announced a dividend of INR22/share.

Key highlights from the management commentary

Deal TCV: TCS reported a record high TCV of USD11.3b, including two mega deals of ~USD1b each (with a tenor of seven-to-ten years). Deal wins stood at USD9.5b, excluding these mega deals. Of these deals, USD3.2b/USD2.6b were in BFSI/Retail. North America posted a TCV of USD6.1b in 4QFY22. It is witnessing a strong deal pipeline, buoyed by robust industry demand.

Cloud: The management reiterated that Cloud will drive growth. TCS enjoys strong partnerships with each hyperscalers. It witnessed ample Horizon 1 deals and believes these deals will fuel short-term growth. The Horizon 1 deals are also opening doors for Horizon 2 deals for TCS.

Margin: Operating margin stood flat QoQ at 25% in 4QFY22. There was a 330bp headwind from increased sub-contractor expenses and wage hikes. Forex provided a 10bp tailwind and the rest of the margin impact was offset by operating leverage. The management is seeing a slight uptick in pricing and the same should flow through to the numbers as contracts get renewed. It reiterated that it would operate in the 26-28% aspirational margin band in the long run, with a planned cost structure, though there will be some volatility and margin pressures in FY23.

Growth to underpin valuation

IT Services has entered into a technology upcycle, with Cloud migration and Digital transformation-led deals coming into the market.

Given TCS’ size, capabilities, and portfolio stretch, it is rightly positioned to leverage anticipated industry growth.

TCS has consistently maintained its market leadership position and shown bestin-class execution. This renders the company with ample room to maintain its industry-leading margin and demonstrate superior return ratios.

We maintain our positive stance on TCS, given its strong growth outlook. Our TP of INR4,240 implies 30x FY24E EPS, with a 15% upside potential. We maintain our Buy rating.

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