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Tata Consultancy Services (TCS) reported in-line revenue growth of 3.5% QoQ in CC terms (1.3% QoQ USD). USD revenue growth was lower due to cross-currency headwinds of 230bps QoQ. Sequential revenue growth was led by retail & CPG, and communications. In terms of markets, the US led with 4.5% QoQ USD growth while muted performance in UK (-2% QoQ USD) and Continental Europe (-3.3% QoQ USD) continued.

Although management expects tech spends to be resilient, we see clear signs of moderation in demand: 1) net headcount addition of 14,136 employees (total headcount up 2% QoQ) vs average of 26K per quarter in FY22 (chart 1). We saw similar moderation in hiring by Accenture (+2% QoQ, net addition of ~12K vs average of 40K per quarter in FY22). 2) Muted growth in deal TCV at US$8.2bn (-27% QoQ, 1% YoY) with book-to-bill ratio at 1.2x vs average of 1.4x in past 8 quarters (charts 2, 3). 3) Weak revenue momentum in Europe for past two quarters. Further, management mentioned that clients in the UK anticipate deeper impact of recession. 4) Moderation in revenue momentum in core verticals, viz. BFSI, retail & CPG (48% of revenue) and muted performance of regional & others segment (16% of revenue) for past 4 quarters (table 5).

Sharp decline in EBIT margins (23.1%, -190bps QoQ) came as a negative surprise. The decline was due to 150bps impact of wage increments and rest due to higher subcon (9.8% of revenue, +120bps YoY, +30bps QoQ) and travel costs. Wage rise was at an average of 4-5% for onsite employees (vs 2-4% normally) and was higher for top performers. LTM attrition increased further to 19.7%, +270bps QoQ. We believe margins have bottomed out and will improve hereon as subcon costs and supply-side cost pressures subside gradually given normalisation of demand going forward. We build-in EBIT margins of 23.9%/24.5% for FY23E/FY24E respectively.

Our earnings estimates are largely intact as we were already 5-7% below consensus. We forecast revenue growth of 8.9% and 7.2% for FY23E and FY24E respectively. TCS has better-than-peers’ supply-side management, breadth of capabilities and deep domain expertise, but the stock is trading premium multiple of 26.2x on FY24E EPS with PEG of 2.4x, which leaves limited room for upside. Reiterate HOLD due to slowing earnings growth and elevated PEG ratios with a fair value of Rs3,140 based on a target multiple of 25x FY24E earnings.

In-line revenue growth.

TCS reported revenue of US$6,780mn, 3.5% QoQ CC, 1.3% QoQ USD. Growth in CC terms was in line with our and consensus estimates. Growth was led by retail and CPG (+4.5% QoQ USD), communications & media (+2.9% QoQ USD) and tech services (+2.4% QoQ USD). In terms of markets, North America (+4.5% QoQ USD) drove growth while muted performance in the UK (-3.3% QoQ USD) and Continental Europe (-0.7% QoQ USD) continued. India revenue declined -4.7% QoQ USD.

Miss in margins.

Margins came in at 23.1%, -190bps QoQ (I-Sec: 1.6%, cons: 1.5%). The quarter witnessed headwinds from wage increments (-150bps) and higher subcon costs and travel expenses. Offshore wage increment was 5-8% while onsite was higher at 4-5% (vs 2-4% normally). Wage increment was higher than normal for top performers. LTM attrition increased further to 19.7%, +230 bps QoQ. We expect attrition to cool down from Q3FY23E given normalisation in demand. We believe margins have bottomed out and will improve hereon as subcon costs and supply-side cost pressures subside gradually given normalisation of demand going forward. Besides, levers of pyramid optimisation, utilisation and INR depreciation will benefit margins, though impact of these will be backended.

Realisation dipped

during the quarter. Lateral hiring was higher compared to freshers. TCS is witnessing pricing benefit in certain pockets. However, we believe pricing will not be a significant margin lever given the high inflationary environment in US and Europe.

Muted growth in TCV.

Orderbook for Q1FY23 stood at US$8.2bn, -27% QoQ and 1% YoY (vs average of US8.7mn per quarter in FY22). Moderation in deal win momentum has set-in. Book-to-bill ratio also lowered to 1.2x vs average of 1.4x per quarter over past 8 quarters. BFSI segment reported deals worth US$2.6bn and North America US$4.6bn. Management expects deal TCV to be in US$7bn-9bn range going forward.

Moderation in hiring momentum.

Net headcount addition of 14,136 employees (up +2% QoQ, +19% YoY) was much lower vs the average 26k per quarter in FY22. Since hiring is lead indicator of demand, moderation in headcount addition signals imminent normalisation of growth. TCS retains its target of hiring 40k freshers in FY23.

Other highlights. Company reported a robust OCF/NI of 114% and declared dividend of Rs8 per share.

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