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Growth & margin reverting to pre-covid average

Even adjusting for covid second wave impact on India business (5.6% of revenues in Mar-21, ~14% QoQ decline), TCS’s growth in Q1FY22 would have been around ~3.1% QoQ (CC). Notably, this is softer than its pre-covid 5-year average growth in June – seasonally the strongest quarter. This further supports our key argument on the sector, i.e. once the low base effect wanes, growth should converge with the pre-covid long-term average.

Europe (~17% of revenues in Mar-21, +1.5% QoQ) remained a key overhang on growth. Order booking (US$8.1bn vs US$9.2bn in Mar21) remained healthy though there were no large deals (>US$500mn) for 2-3 quarters now. Given the increasing deal tenures and the limited knowledge about project completions, correlating orderbooking with future sales growth is difficult, in our view.

While India business is likely to see a pent-up in Sep-21, Europe is guided to remain soft for another 1-2 quarters. In the likely scenario of clients returning to offices, management indicated office work may become inevitable. Further, TCS expects most of its discretionary costs (including travel) to return by the end of the fiscal.

This result and commentary reinforce our anti-consensus argument that growth and margins of the industry in the post-covid equilibrium will be largely similar to pre-covid levels (elaborated in our Oct-20 thematic). As disappointments (on consensus earnings) related to this continues, the current lifetime-high multiples (30x FY23E EPS) are unlikely to sustain. We downgrade the stock to REDUCE (from Hold earlier).

* Tepid revenue growth in a seasonally strong quarter. TCS reported revenue growth of 2.4% (QoQ, CC) – lower than our and consensus expectations. Continental Europe (+1.5% QoQ, CC) remained a key overhang on overall growth. India business was significantly impacted by covid second wave. However, even adjusted for the impact on India business, growth (3.1% QoQ, CC) would have still been relatively soft in the seasonally strongest quarter. This further corroborates our key argument, i.e. once the low base effect wanes, growth should converge with the pre-covid long-term averages. EBIT margins contracted 130bps QoQ, largely in line with consensus estimates and lower than our estimates. Salary hikes (-170bps QoQ impact) and INR depreciation (+30bps impact) were the key margin movers for the quarter.

* Downbeat commentary on growth and margins; Downgrade to REDUCE. This result and commentary reinforce our anti-consensus argument that growth and margins of the industry in post-covid equilibrium will be largely similar to pre-covid levels (elaborated in our Oct-20 thematic). As disappointments (on consensus earnings) related to this continue, the current lifetime-high multiples (30x FY23E EPS) are unlikely to sustain. Downgrade to REDUCE (from Hold earlier).

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