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Robust core growth and deal wins to drive expansion

Valuation continues to factor in performance

* Tata Consultancy Services (TCS) reported revenue growth of 2.4% QoQ CC in 1QFY22, below our estimate of 3.6%. This was primarily due to sharp degrowth in its India business (-14.1% QoQ) on account of the second COVID wave. Excluding the impact in regional markets, core business growth of 4.1% QoQ CC was broadly in-line. The EBIT margin at 25.5% (marginally above our estimates) declined 130bp QoQ, primarily due to annual wage hikes (170bp impact).

* TCS delivered another quarter of strong deal wins (USD8.1b), with a bookto-bill ratio of 1.3x, despite the absence of any mega deals. TCS has consistently reported a book-to-bill ratio above 1.0x, without support from USD500m+ deals (4QFY21 record TCV comprised just one such deal). We see this as positive for the company as it should improve growth visibility.

* Consistent performance from TCS, post the initial phase of the COVID pandemic, indicates continued strength in the tech spending environment, along with its ability to capture outsized market share. Management commentary on enterprise demand, especially cloud, implies a positive outlook for peers as well.

* We see LTM attrition increasing 140bp QoQ as an indication of elevated supply constraints in the industry and expect this to be visible in TCS’ peers as well. Additionally, the company’s hiring streak has continued (the highest ever net employee additions of 20.4k QoQ / 65.3k YoY), indicating a robust demand environment. It further instills the confidence that this trend would persist.

* We expect TCS to be relatively better positioned (v/s the sector) to leverage the acceleration in large deals as clients increase their spending on cloud. Backed by strong deal wins and continued momentum in the Cloud and Data spaces, we expect the company to deliver a ~15% USD growth CAGR over FY21–23E.

* TCS reported OCF/PAT of 114% and FCF/PAT of 108% on good working capital management, indicating the ability to generate strong cash flow.

* We have marginally changed our EPS estimates. While we continue to be positive on the company, we remain Neutral on the stock given the elevated multiples. Our TP of INR3,400 implies 27x FY23E EPS.

Revenue miss on India decline, in-line margins

* For 1QFY22, (a) USD revenue grew 21.6% YoY (v/s est. 22.8% YoY), (b) INR revenue grew 18.4% YoY, (c) EBIT was up 28% YoY (in-line), and (d) PAT rose 28% YoY (est. 32.5% YoY).

* CC revenue was up 2.4% QoQ, below our estimate of 3.6% QoQ CC. On a YoY basis, revenue was up 16.4% YoY CC.

* Industry Verticals (ex-Regional Markets) grew 4.1% QoQ and 18.5% YoY in CC terms.

* USD revenue was up 2.7% QoQ v/s our estimate of 3.8% QoQ. On a YoY basis, USD revenue was up 21.6% YoY.

* Growth was broad-based across verticals, led by Lifesciences and Healthcare (+7.3% QoQ, +25.4% YoY), followed by Retail & CPG (+4.4% QoQ, +21.7% YoY). BFSI (+3.1% QoQ, +19.3% YoY), Manufacturing (+4.8% QoQ, +18.3% YoY), Technology & Services (+5% QoQ, +12.3% YoY), and Communications & Media (+1.7% QoQ, +6.9% YoY) also posted significantly improved performances.

* Growth was dominated by continental North America (+4.1% QoQ CC); the UK also saw healthy growth of 3.6% QoQ CC. Continental Europe was up 1.5% QoQ. The second COVID wave impacted sequential growth in India (-14.1% QoQ, +25.3% YoY).

* Weakness in India was due to the underperformance of the Platform ION and Public Sector Projects businesses. The total impact of the same stood at INR3.5b. Some recovery was seen in June.

* Overall TCV stood at USD8.1b, down 12% from the peak of 4Q.

* The EBIT margin came in at 25.5% (est. 25.2%; down 130bp QoQ), largely led by the impact (of 170bp) of a second wage hike.

* PAT was up 28% YoY to INR90b, implying a 3% miss on our estimates.

* 1Q saw the highest net additions of employees – 20.4k QoQ to reach 509,058 – despite the higher base of the previous quarter.

* LTM attrition inched up 140bp QoQ to 8.6%.

* Net cash from operations increased 11% YoY to INR102.9b (i.e., 114.3% of net income). Free cash flow rose 12.4% YoY to INR97.5b (i.e., 108% of net income).

* Total cash and equivalents by the end of the quarter stood at INR545b.

* TCS announced dividend per share of INR7.

Key highlights from management commentary

* TCS reported strong TCV of USD8.1b, of which USD2.2b was in BFSI and USD1.5b in Retail (highest ever for the second sequential quarter). North America reported TCV of USD4b.

* Growth was broad-based across verticals and geographies, led by Lifesciences and Healthcare. BFSI was powered by increasing investments, while Retail & CPG bounced back on Discretionary Retail and a portion of Hospitality & Travel starting to show recovery. The impact of the second wave led to 14% sequential decline for India. However, the management stated this was temporary and revenues would return.

* Going forward, growth revival would aid margin expansion. However, the management expects some of the discretionary expenses to return to preCOVID levels, offsetting the expansion. The management guided for stable margins in FY22.

Valuation and view – rich multiples justified

* IT Services has entered into a technology upcycle, with cloud- and data-driven deals coming into the market.

* Given TCS’ size, capabilities, and portfolio stretch, it is rightly positioned to leverage expected industry growth.

* The company has consistently maintained its market leadership and shown bestin-class execution. This gives the company continued room to increase its margin, while demonstrating industry-leading return ratios.

* Our TP implies 27x FY23E EPS. While we remain positive on the company, we maintain Neutral given the rich multiples.

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