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ARA: Innovating for ‘greater futures’

Tata Consultancy Services’ (TCS) FY22 annual report (AR) highlights the theme of ‘Innovating for Greater Futures’ referring to the accelerated innovation in enterprises as they shift from improvising (to cope with the challenges of the pandemic) to growth and transformation. The AR highlights the increased cloud adoption as clients embarked on multi-horizon cloud transformation journeys, and increase in outsourcing-led deals. Management states, through the AR’, that though the geopolitical tensions in Europe and their impact on global economic growth are real threats, enterprises spending on technology are far more resilient. While the evolving market dynamics may reprioritise programs, management is confident that technology spend will continue to grow and lead to sustained momentum for the company. While it expects supply-side headwinds to persist in FY23 along with increase in travel and facility expenses, focus is to keep margins stable in the medium term. The 26-28% margin band however remains the long-term aspiration for the company. The full-year orderbook was at US$35bn for FY22, a book to bill ratio of 1.3x. Company witnessed a sharp spike in employee costs which grew 17% in FY22 (vs 7% in FY21). This was largely due to the supply-side crunch leading to increased hiring costs, retention costs and higher than average wage hikes during the year. The stock is currently trading at 28x/25x on FY23E/FY24E EPS of Rs117/130. Maintain HOLD with a target price of Rs3,168.

* Confident of growth in tech spend despite macro uncertainties. Management states, through the AR, that though geopolitical tensions in Europe and their impact on global economic growth are real threats, enterprises investing in technology are far more resilient. While evolving market dynamics may reprioritise programs, management is confident that technology spend will continue to grow.

An all-time high orderbook, continued deal flow and pipeline gives management the confidence to sustain its business momentum and a certain base case growth with room to maximise in better years. Management highlighted that the company is in the midst of a multi-year technology upgrade cycle that provides strong, structural growth drivers for the next few years

* Expect stable margins in the medium to long term. In FY22, wage hikes and tactical interventions resulted in a 330bps margin headwind, of which 270bps was offset by operating leverage, improve realisations and cross-currency tailwinds. While management expects supply-side headwinds to persist for FY23 along with increase in travel and facility expenses, the same should be offset by large fresher hiring, revenue growth leverage and improved realisations. The focus is to keep margins stable in the near term and 26-28% remains the long-term aspirational band.

* New organisation structure. TCS rolled out a new, industry-first organisation structure at the end of FY22 that further enhances the company’s customer centricity. It has arranged its existing units into three business groups, each aligned to a particular phase in the customer relationship journey: 1) Relationship Incubation Group that will provide the high-touch, high-engagement, delivery-focused model required by new clients; 2) Enterprise Growth Group which will pull together capabilities from across the different service lines to stitch together solutions addressing client business needs when the relationship is in its hyper growth phase; and 3) Business Transformation Group that will manage the largest clients and help them accomplish their growth and transformation objectives.

* Sustainability-led innovation. The AR highlighted that a new trend in FY22 was the growing volume of sustainability-led innovation, which has become a top priority items on most CEO agendas. This is in addition to the wave of business innovation in the form of ‘Horizon Two’ or ‘Horizon Three’ initiatives undertaken by the clients. Clients across industries such as retail, manufacturing, utilities and consumer goods are engaging TCS to reduce energy consumption, or to measure and track greenhouse gas emissions across their end-to-end supply chain, reduce their carbon footprint, reduce waste and promote recycling.

Company has leveraged its expertise in IoT, advanced analytics, and machine learning to come up with a suite of offerings in this space, including intellectual properties such as Clever Energy, IP2, and TCS Envirozone.

* Vendor consolidation trend intact. Management mentioned that vendor consolidation is typically done to find an alternative strategic provider with a richer set of capabilities and a superior execution track record. However, the sharp recovery and subsequent growth in demand, coinciding with the great resignation and talent scarcity, have resulted in enterprises focusing more on pursuing their immediate technology priorities. That said, while the industry grew 6%, all the toptier players grew in double-digits, indicating that the longer-term consolidation trends are very much intact.

* All-time high orderbook. The TCV of deals signed in the first three quarters of FY22 averaged between ~US$8bn per quarter, capped by an all-time high orderbook of US$11.3 billion in the fourth quarter. Even after excluding two mega deals of ~US$1bn each, the TCV in Q4FY22 was US$9.5bn, which is also an alltime high. The full-year orderbook was US$35bn (highest ever), working out to a book to bill ratio of 1.3x.

* Strong freshers addition. TCS onboarded 118k freshers in FY22 to address the structural problem of talent scarcity vs initial target of 40k. Net headcount increased by 21% to 592,195 with net addition of 103,546 employees during the year. LTM attrition at 17.4% is higher than the company average, but lower than peers.

Company also announced plans to grow operations in New Jersey by hiring 1k employees by end of FY23 and invest US$300mn by FY26 to expand in Arizona, hiring over 220 employees by FY23.

Company witnessed a sharp spike in employee costs growth to 17% in FY22 (vs 7% in FY21). This was largely due to supply-side crunch leading to increased hiring costs, retention costs and higher than average wage hikes given by the company during the year.

* Performance of products and platforms in FY22- bit sluggish for TCS BaNCS: Ignio (cognitive automation platform) reported 100+ deal wins during the year, which is quite impressive in our view. TwinX (enterprise digital twin platform) had 20 new wins in FY22 (vs 7 in FY21) while TCS BaNCS (banking software suite) had 22 wins in FY22 vs 23 and 29 wins in 2020 and 2018

* Stable cash conversions. OCF/EBITDA for FY22 was at 75.3%, a decline compared to FY21 (83.4%) but largely in line with pre-covid levels. TCS announced a total dividend Rs43 per share for FY22 in addition to its fourth buyback in five years, to the tune of Rs180bn, resulting in a total payout of ~103% of the free cashflow and ~99% of PAT.

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