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Margins dip on supply side challenges…

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%)

Q3FY22 Results: TCS reported Q2FY22 results.

* US$ revenues grew 3% QoQ to $6,333 million, up 15.4% YoY in CC terms

* EBIT margins declined 60 bps QoQ to 25.0%

* The company’s deal pipeline continues to be healthy at US$7.6 billion

What should investors do? TCS’ share price has grown by ~3.9x over the past five years (from ~| 1,018 in January 2017 to ~| 3,965 levels in January 2022).

* We continue to remain positive and retain our BUY rating on the stock

Target Price and Valuation: We value TCS at | 4,600 i.e. 34x P/E on FY24E EPS

Key triggers for future price performance:

* TCS is key beneficiary of multi-year growth (15-20%) in digital technologies

* Increase in outsourcing in Europe, vendor consolidation and deal pipeline leading to revenue CAGR of 13% over FY21-24E

* We expect margins to be under pressure, at least in FY23E, before stabilising at 25.8% in FY24E, resulting in margin improvement of only 50 bps in FY21-24E

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

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

* Improving revenue growth, narrowing margins with industry leader and healthy payout

* BUY with a target price of | 2,300

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