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Discretionary spending remains lukewarm

Stable growth led by India geography; reiterate BUY

* TCS reported revenue of USD7.5b in 1QFY25, up 1.9% QoQ in USD terms, beating our estimate of ~1.3%. Growth was driven by strong performances in India (up 14.1% QoQ/59.0% YoY, aided by BSNL scale-up), the UK (up 2.5% QoQ) and North America (up 0.9% QoQ). TCS reported a deal TCV of USD8.3b, within its usual range but down 37.1% QoQ and 18.6% YoY. The book-to-bill ratio was 1.1x.

* BFSI, particularly the banking clients in the US, returned to growth in the quarter. The nature of demand was largely the same, and clients continued to prioritize cost optimization projects.

* While growth was driven by the BSNL deal ramp-up, verticals in key markets such as communications and retail continued to be weak. The ~4% decline in communications was concerning, as there was a growing consensus that spending cuts in the sector had bottomed out after a weak FY24. A fed pivot is probably a meaningful catalyst for telecom clients, but we believe a more meaningful turnaround in this vertical could only be seen once network rollout capex trickles down to services spending/opex. This could be more gradual even in case of rate cuts, in our opinion.

* We believe the BSNL deal and other large deal ramp-ups should cushion TCS’s revenue growth in FY25. We expect FY25 revenue growth of an admirable 5.5% YoY in constant currency. For FY26, we bake in a mild recovery in discretionary spending and expect ~8% revenue growth.

* EBIT margin for 1Q declined by 130bp QoQ to 24.7%, due to seasonal wage hikes, but beat our estimate of 24.5%. Attrition (LTM) decreased by 40bp QoQ to 12.1%. 1Q PAT increased by 8.7% YoY; in line with our expectations at INR120b (19.2% PAT margin).

*  With wage hikes executed this quarter, we believe major headwinds to margins are now behind, and TCS should deliver full-year EBIT margin of 25.4% in FY25, up 70bp YoY, despite limited incremental cost levers at its disposal. The margin recovery in 2HFY25 will likely be driven by continued workforce optimization toward freshers and platforms. We expect FY25E/FY26E EBIT margins to be at 25.4%/25.5%, up from 24.7% in FY24.

* We have broadly maintained our FY25/FY26 EPS estimates. Over FY24-26E, we expect a USD revenue CAGR of ~6.9% and an INR EPS CAGR of ~10.9%. Our TP of INR4,660 implies 30x FY26E EPS, with a 19% upside potential. We reiterate our BUY rating on the stock.

Key highlights from the quarter

* USD revenue grew 1.9% QoQ to USD7.51b. YoY CC growth was 4.4%

*  1Q growth was driven by India and UK. MEA/Latin America declined by 2.9%/3.2% QoQ. Vertical growth was strong in Mfg and regional markets, while BFSI and Technology & Services reported growth after a few quarters. Communications and Media remains under pressure

* EBIT margin came in at 24.7% (down 130bp QoQ), above our estimate of 24.5%. Margin walk: There was a 170bp impact from wage hikes and third-party costs, offset by better utilization, productivity, and reduced subcontracting costs.

* The net headcount addition was 5,452 in 1QFY25.

* Dividend of INR10/share in 1Q.

Key highlights from management commentary

* Given the uncertain macro environment, clients are focusing on realizing immediate benefits. The current spending is led by cost optimization and vendor consolidation programs.

* Discretionary spending remains under pressure. Transformation projects will be funded by savings from cost optimization initiatives.

* BFSI clients are expected to increase spending on an integrated cloud model. There is some positive movement in BFSI, with the US BFSI vertical growing more than the UK BFSI vertical this quarter.

*  There was broad-based growth in all sub-sectors of the manufacturing vertical. For communication vertical, slowdown is led by previous heavy investments in 5G rollout by many telcos without seeing better ROI, which have now led to lower investments by telcos. Further, clients in this vertical are looking for lower interest rates for additional investments. Hence, lower interest rates would be the trigger/catalyst for growth in this vertical.

* Pyramid optimization, utilization in the short term, and pricing and revenue growth should be long-term margin levers. The company announced doubledigit wage hikes for high performers and 4-7% wage hikes overall.

* FY25 is expected to be better than FY24, with broad-based growth across verticals and geographies providing confidence.

Valuation and view

* Given its size, order book and exposure to long-duration orders and portfolio, TCS is well positioned to withstand the lukewarm macro environment.

*  Owing to its steadfast market leadership position and best-in-class execution, the company has been able to maintain its industry-leading margin and demonstrate superior return ratios.

*  We maintain our positive stance on TCS. Our TP of INR4,660 implies 30x FY26E EPS, with a 20% upside potential. We reiterate our BUY rating

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