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Q4FY23 performance: Tata Consultancy Services (TCS) reported revenues of US$7,195mn, +0.6% QoQ CC, +1.7% QoQ USD, above our estimate of +0.1% QoQ CC, but lower than consensus expectations of ~0.9% QoQ CC. Soft revenue growth during the quarter was due to pause in discretionary spends. EBIT margin came in at 24.5%, flat QoQ, lower than our and consensus expectations of 25% due to higher onsite manpower costs led by replacement of subcontractors and additional onsite hiring. Plus, likely unanticipated pausing of discretionary revenue impacted margins as manpower costs were sticky. Overall PAT was lower by ~1.4% than consensus estimates due to miss on margins.

Orderbook at US$10bn for Q4 was relatively strong on QoQ basis, but down 11.5% YoY, and it includes a mega deal worth US$700mn with Phoenix Group. TCV was broad-based with North America TCV at US$5bn, BFSI TCV at US$3bn, retail TCV at US$1.3bn. Headcount growth was quite weak at 0.1% QoQ with net addition of 821 employees. Attrition fell 4% QoQ indicating easing of supply-side pressures.

Demand outlook: Demand was characterised by weak sentiment due to recent events in the global banking industry and overall weak macro. BFSI, retail and hi-tech verticals continued to exhibit softness in the US and Europe during the quarter. However, deal pipelines have not shrunk and have been replenished. Discretionary spends have been postponed, but demand for large cost optimisation and digital transformation deals is stable. Management also mentioned that ‘TCV to revenue’ conversion is likely to be faster in FY24 because order book of US$34bn at start of FY24 is less lumpy compared to that at the start of FY23, comprising of higher mid-sized deals (US$50mn-100mn).

What to do with the stock?

Due to a slight EPS miss in Q4FY23 due to margin disappointment, we are cutting our FY24E-FY26E EPS estimates by 1-2% as we now assume lower margins for TCS. We havenot cut our revenue growth forecasts of FY24E/FY25E/FY26E, which remain at7%/11%/12% in CC terms and are pencilling-in weak sequential growth of 0.5% in CC terms in Q1FY24E, followed by a steady ramp-up in the remaining 9MFY24E. This isassuming our base case of no recession in the US or globally in the near to medium term. We believe TCS remains a defensive play in the current environment where they are gaining market share by aggressively winning cost optimisation deals (reflected in their strong deal TCV during Q4FY23). We also believe TCS will be a strong beneficiary of pick-up in demand in FY25E as currently-postponed discretionary projects start getting executed. Maintain BUY on TCS with a 12-month target price of Rs3,786 (i.e. based on 25x FY26E EPS of Rs 171, discounted back by WACC of 12%) implying 17% potential bupside. Key risks to our thesis remain: negative sentiment in the BFSI vertical persisting longer than expected leading to weak growth in FY25E as well, and its impact percolating to other industry verticals like retail, hi-tech, etc.

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