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Q1 a tad below estimates; remains cautiously optimistic

* Q1FY23 operating performance was a tad below expectations. Revenue grew 1.3% QoQ to USD6.78bn (3.4%/15.5% QoQ/YoY CC). EBITM declined 190bps QoQ to 23.1% due to salary hikes, higher backfilling costs due to attrition and an uptick in travel expenses.

* Revenue growth was broad-based and led by Retail & CPG (25.1% CC YoY), Communication and Media (19.6%), Manufacturing (16.4%), Technology & Services (16.4%), BFSI (13.9%), and Life Sciences & Healthcare (11.9%).

* Deal intake was steady with USD8.2bn TCV (book-to-bill at 1.2x). The deal pipeline velocity and deal closures remained strong; however, considering macro uncertainties, management remains watchful. TCS expects technology spending to remain resilient and expects the secular tailwinds to drive healthy growth over the medium term.

* We cut FY23-25 EPS estimates by 1-3% due to the Q1 miss. The demand environment remains healthy in the near term; however, macro uncertainties weigh on valuations. We maintain Hold with a revised TP of Rs3,200 at 23x Jun’24E EPS (earlier TP Rs3,250).

What we liked? Broad-based revenue growth, healthy cash generation (OCF/EBITDA of 80.6% in Q1), healthy deal intake (USD8.2bn TCV; 2 deal wins of USD400+mn TCV each)

What we did not like? Elevated attrition (LTM attrition inched up to 19.7% in Q1 vs. 17.4% QoQ); softness in regional markets (second quarter of muted sequential growth)

Broad-based revenue growth performance:

Revenue rose 1.3% QoQ to USD6.78bn (CC 3.4%), a tad below our/consensus estimates. The overall demand outlook remains healthy for the near term, with high visibility for project funding, greater cloud adoption and steady momentum in transformation and optimization projects. Q1 saw broad-based growth across all services, led by Cloud, Consulting & Service Integration, Cognitive Business Operations and Enterprise Application Services. Key themes driving growth and transformation demand in Q1 were customer experience, cloud transformation and sustainability. TCS is seeing a selective uptick in pricing; however, realization fell sequentially in Q1 due to capacity creation. It experienced increased discussions on macro uncertainties, inflation and geopolitical situations with senior leaders/CXO at client organizations, particularly in Europe. However, at the operational level, business momentum remains healthy, and TCS has not experienced any softness or decision delay. TCS signed deals worth USD8.2bn in Q1, with a book-to-bill ratio of 1.2x. Management indicated that the deal pipeline remains well distributed across deal sizes. Management remains confident of sustaining growth momentum in the near term on the back of broad-based demand and healthy deal wins/deal pipeline.

Salary hikes and supply-side challenges weigh on margins:

EBITM was down 190bps sequentially due to wage hikes (-150bps), supply-side issues, and an uptick in travel costs, partly negated by favorable currency movements (+25bps). Pyramid optimization, better realization, rupee depreciation, and operational efficiencies should drive gradual margin improvement in the coming quarters, and management expects EBITM to recover to ~25% by the end of the year.

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