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Strong CC growth; weak margins

About the stock: Tata Consultancy Services (TCS) is one of the leading IT service providers with a presence in BFSI, communication, manufacturing, retail & hi tech.

* Consistent organic revenue growth and industry leading margins (>25%)

* Stable management, robust return ratios (>RoCE 40%) & payouts (~70%)

Q1FY23 Results: TCS reported weak margins.

* CC growth of 3.5% QoQ, 15.5% YoY was better than expected

* EBIT margins declined ~185 bps QoQ to 23.1% for the quarter

* The company’s TCV was at US$8.2 billion (bn) at Q1FY23

What should investors do? TCS’ share price has grown by ~2.8x over the past five years (from ~| 1,165 in July 2017 to ~| 3,265 levels in July 2022).

* We maintain BUY rating on the stock

Target Price and Valuation: We value TCS at | 3,785 i.e. 29x P/E on FY24E EPS

Key triggers for future price performance:

* New organisation structure, which is aimed at increasing customer stickiness is expected to enhance market share gains

* Increase in outsourcing in Europe, vendor consolidation and deal pipeline leading to revenue CAGR of 12.2% over FY22-24E

* We expect margins to be under pressure till FY24, resulting in margin contraction of 30 bps in FY22-24E

* Double-digit return ratios, strong cash generation and healthy payout

Alternate Stock Idea: Besides TCS, in our IT coverage we also like Infosys.

* Key beneficiary of improved digital demand, industry leading revenue growth and healthy capital allocation prompt us to be positive

* BUY with a target price of | 1,745

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