Buy Tata Consultancy Services Ltd For Target Rs.5,000 By Motilal Oswal Financial Services Ltd
A sunny turn for tech spends
Positive broad-based outlook heralds a return of discretionary spends
*TCS reported revenue of USD7.5b in 3QFY25, down 1.7% QoQ in USD terms vs. our estimated decline of 0.3%. Growth was driven by India (up 8.2% QoQ/66.3% YoY) and MEA (up 7.7% QoQ), while North America was down 1.5% QoQ. EBIT margins came in line with our estimate at 24.5% (up 40bp QoQ). PAT was up 4.1% QoQ/12.1% YoY at INR124b (below our est. of INR127b). For 9MFY25, revenue/EBIT/PAT increased by 6.2%/7.3%/8.5% compared to 9MFY24. In 4QFY25, we expect revenue/EBIT/PAT to grow by 7.2%/7.2%/9.5% YoY. TCS reported a deal TCV of USD10.2b, up 18.6% QoQ and 25.9% YoY. The book-to-bill ratio was 1.4x. We reiterate our BUY rating on TCS with a TP of INR5,000, implying a 24% potential upside.
Our view: Discretionary spending revival closer than ever
*The headline revenue numbers remained flat, but the deal win TCV was encouraging, signaling potential momentum pick-up ahead. While FY24 also saw strong deal closures, FY25 revenue growth is being impacted by a higher proportion of mega cost-saving deals, which likely carried lower annual contract values, coupled with severe ramp-downs in critical client projects.
*Looking ahead to FY26, a recovery in discretionary client spending and a strong US economy could present a more favorable growth environment. While BSNL ramp-down is still a key risk, we believe improving deal closing cycles and the strong TCV showing in 3Q should offset some of that impact.
*We are also encouraged by the absence of "mega deals" in 3Q TCV, suggesting a return of short-cycle deals. The company's comments also corroborate our thesis (Technology: Bounce-back! Charting the path to revival for IT services) that clients are transitioning out of cost-takeout deals into application modernization and data engineering initiatives.
*Overall, we believe tech spend recovery, which over the past six months was heavily reliant on BFS, is now spreading to other verticals such as Hi-tech and Retail.
Valuations and change in estimates
*We keep our estimates largely unchanged. Over FY24-27E, we expect a USD revenue CAGR of ~6.0% and an INR EPS CAGR of ~9.3%. Our TP of INR5,000 implies 30x FY27 EPS, with a 24% upside potential. We reiterate our BUY rating on the stock.
Slight miss on revenues with in-line margins; TCV deal wins strong at USD10.2b
*USD revenue came in at USD7.5b, down 1.0% QoQ CC (assuming 70bp cc headwind) – below our estimate. YoY CC growth was 4.5%.
*3Q growth was driven by India. North America declined by 1.5% QoQ. BFSI/Manufacturing declined 2.7%/4.0% QoQ in USD terms, whereas regional markets and others grew by 2.7% QoQ
*EBIT margin was 24.5% (up 40bp QoQ), in line with our estimate. ? TCS reported a deal TCV of USD10.2b, up 18.6% QoQ and 25.9% YoY.
*Attrition (LTM) increased by 70bp QoQ to 13%. PAT was up 4.1% QoQ/12.1% YoY at INR124b (below our est. of INR127b). ? The net headcount reduced by 5,370 employees (down 0.9% QoQ) in 3Q. ? TCS declared an interim dividend of INR10/share and a special dividend of INR66/share in 3Q.
Key highlights from management commentary
*Improvement is being seen in discretionary spending. Client conversations are showing early signs of revival in discretionary spending.
*Revenue realization is expected to improve compared to past quarters due to shorter deal cycles and increased discretionary spending by clients, leading to better revenue productivity.
*The manufacturing sector is expected to bottom out in 4Q. Life sciences and healthcare sectors, which are waiting for policy clarifications, should start performing better as near-term headwinds subside.
*Deal cycles have shortened by a few weeks in this quarter compared to the last, indicating improved decision-making cycles by clients.
*There is an increased proportion of deals related to application modernization, cloud, and data, driven by the adoption of generative AI (Gen AI) by clients.
*Manufacturing continues to experience softness due to industry and macroeconomic issues. However, TCV addition has been strong.
*3Q growth was driven by the Indian market. While the BSNL ramp-up was a substantial driver, there was also growth in non-BSNL revenues.
*EBIT margins stood at 24.5%, up 40bp QoQ, despite headwinds from furloughs and seasonality. This was offset by operational efficiencies achieved through productivity improvements, utilization, and the pyramid structure.
Valuation and view
*Given its size, order book and exposure to long-duration orders and portfolio, TCS is well positioned to grow over the medium term.
*Owing to its steadfast market leadership position and best-in-class execution, the company has been able to sustain its industry-leading margin and demonstrate superior return ratios.
*We maintain our positive stance on TCS. Our TP of INR5,000 implies 30x FY27E EPS, with a 24% upside potential. We reiterate our BUY rating on the stock.
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