IGI Logo

Growth optimism intact, but near term hiccups limit upside

Soft 2Q performance to overshadow outlook

* In line CC growth, but miss on USD revenue and margin: TCS reported an in line revenue growth of 4% QoQ CC in 2QFY22. However, USD revenue growth (2.9% QoQ) missed our estimate of 3.7% QoQ growth. EBIT margin expanded by 10bp QoQ to 25.6%, but was lower than our estimate of 26.2%, on supply side challenges. PAT stood at INR97b, up 6.9% QoQ, aided by higher other income and stable ETR. The company reported an OCF/PAT of 103% and a FCF/PAT of 97% on good working capital management, indicating the ability to generate strong cash flow. 1HFY22 USD Revenue/EBIT/PAT grew 19.1%/20.6%/28.4% YoY.

* Deal wins stable: Deal wins in 2QFY22 stood at USD7.6b (-6% QoQ), implying a book-to-bill ratio of 1.2x. TCS saw another quarter of a healthy mix of deals across sizes. Overall TCV was up 25% YoY after excluding one mega deal from the 2QFY21 base. Steadiness in deal wins, despite the absence of mega deals, is encouraging for the company as well as the sector.

* Demand environment strong: The management commentary on the overall demand environment continues to remain upbeat. It sees increased technology intensity from enterprise customers and expects demand momentum to continue in the medium term. Cloud adoption is at initial stages as only 20-30% workloads have moved to the Cloud.

* Supply-side challenges: LTM attrition for TCS rose 330bp QoQ to 11.9%, indicating a clear supply-side crunch in the industry. At the same time, it had a strong net addition of 19.7k employees QoQ (~43k freshers in 1HFY22). The management said supply-side challenges will continue to remain high for the next 2-3 quarters before normalizing. We see current supply-side challenges as transient and expect normalization in the medium term.

* Margin to remain soft in the near term: 2HFY22 is seasonally strong for margin, given the absorption of wage hikes and operating leverage. However, the management has indicated that margin in the near term can be soft, led by ongoing supply-side challenges.

* Estimates and valuation: We have reduced our EPS estimates by 2%/4% for FY22E/FY23E. We expect 14.3%/18.4% USD revenue/EPS CAGR over FY21- 23E. Our TP of INR3,770 per share, implies 31x FY23E EPS. We maintain our Neutral rating.

Miss on revenue and margin

* Revenue in USD terms grew by 16.8% YoY (est. 17.6%). In INR terms, it grew by 16.8% YoY. EBIT/PAT grew by 14%/28.6% YoY (PAT est. 30.4%) in 2QFY22.

* CC revenue up 4% QoQ, in-line with our estimate of 4.2% QoQ CC. On a YoY basis, revenue grew by 15.5% YoY CC.

* In USD terms, revenue was up 2.9% QoQ v/s our estimate of 3.7% QoQ. On a YoY basis, revenue in USD terms was up 16.8 YoY.

* Growth was broad based across verticals, led by Technology and Services (+5.3% QoQ), Communications and Media (+4.5% QoQ), Retail and CPG (+4.3% QoQ), and Manufacturing (+4% QoQ). Core vertical BFSI grew 2.6% QoQ, while sequential growth in Life Sciences and Healthcare (+0.9% QoQ) slowed down after four quarters of high growth.

* Growth was dominated by North America (+4.8% QoQ). UK also posted a healthy growth (+1.6% QoQ), while Continental Europe witnessed a 2% QoQ decline. India business posted a strong (+14.1% QoQ) growth on a low base.

* EBIT margin stood at 25.6% (est. 26.2%), up 10bp QoQ, impacted by supply-side challenges and currency headwinds.

* PAT grew 29% YoY to INR97b, 1.4% miss to our estimate.

* For 1HFY22, USD Revenue/EBIT/PAT grew 19.1%/20.6%/28.4% YoY.

* Overall TCV stood at USD7.6b, down 6% QoQ.

* 2QFY22 saw a strong net addition of employees at 19.6K QoQ to 528,748, despite a higher base in the last few quarters.

* LTM attrition inched up to 11.9%, an increase of 330bp QoQ.

* Net cash from operations dipped by 6% YoY to INR99.45b (i.e. 103% of net income). Free cash flow fell 17% YoY to INR93.6b (i.e. 97% of net income).

* Total cash and investments at the end of 2QFY22 stood at INR605b.

* TCS announced a dividend of INR7/share.

Key highlights from the management commentary

* Deal TCV: Deal wins continue to remain strong, backed by deals of all sizes. On a YoY basis, deal wins grew 25% after excluding one large deal from the 1QFY21 base. Growth and transformation deals are smaller in size, but their duration is also lower. On an ACV basis, they are similar to other deals.

* Europe business: Continental Europe business was soft (-2% QoQ) and was impacted by: 1) closure of one large engagement, 2) impact from multiple industry verticals, and 3) offshoring. The management said that deal wins in Europe have accelerated and the outlook continues to remain strong.

* Margins in 2QFY22 were stable and were impacted by supply-side challenges and currency headwinds. The management expects continued headwinds from supply-side challenges in 2HFY22, which will have an impact on margin performance.

* Growth outlook: The management sees one of the strongest demand environments in recent times and expects strong growth to continue in the medium term

Valuation and view – High valuations leave no room for disappointment

* IT Services has entered into a technology upcycle, with Cloud migration and Digital transformation-led deals coming to 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 maintain its industry-leading margin and demonstrate industry-leading return ratios.

* We remain positive on the company, given its strong growth outlook. But high valuations leave limited room for disappointment. A miss on estimates in 2QFY22, coupled with a soft margin outlook, can result in near term pressure on the stock. Our TP of INR3,770 per share implies 31x FY23E EPS. We maintain our Neutral rating.

To Read Complete Report & Disclaimer Click Here

For More Motilal Oswal Securities Ltd Disclaimer http://www.motilaloswal.com/MOSLdisclaimer/disclaimer.html SEBI Registration number is INH000000412

Above views are of the author and not of the website kindly read disclaimer