Buy TCS Ltd for the Target Rs 2,400 by Motilal Oswal Financial Services Ltd
Growth outlook unchanged; margins under pressure International growth picks up; AI-led deflation concerns unchanged
* TCS reported 2QFY27 USD revenue of USD7.6b, rising 0.5% QoQ in CC, in line with our estimate of 0.5% QoQ CC growth. 2Q growth was led by Manufacturing/Hi-Tech/BFSI, which grew 3.1%/3.1%/2.5% QoQ CC, while regional markets/consumer business declined 5.8%/0.7% QoQ CC. EBIT margin stood at 24% (flat QoQ), below our estimate of 25%. Adj PAT remained flat QoQ and rose 7.5% YoY at INR139b, below our est. of INR144b.
* In INR terms, 1HFY27 revenue/EBIT/adj. PAT grew 12.6%/8.7%/8.1% YoY. In 2HFY27, we expect revenue/EBIT/adj. PAT to grow 6.5%/4.3%/4.9% YoY. TCS reported a deal TCV of USD9.6b in 2QFY27, rising 1.1% QoQ but declining 4% YoY. The book-to-bill ratio stood at 1.3x. We reiterate our BUY rating on TCS with a TP of INR2,400, implying a 16% potential upside.
Our view: Margins to remain under pressure in the near term
* International business accelerated QoQ, with USD revenue growth of 1% versus a 0.2% decline in 1QFY27 (Exhibit 2), led by the UK (+3.7% QoQ), while North America remained flat. Growth also broadened across BFSI (+2.5% QoQ CC), manufacturing (+3.1% QoQ CC), and Hi-tech (+3.1% QoQ CC). The improving mix across BFSI, manufacturing, and technology services provides some visibility for sustained momentum in international markets.
* Demand commentary saw no meaningful change, with discretionary programs continuing to see measured decision making. While TCV increased to USD9.6b and client conversations remained constructive, we believe the near-term outlook remains dependent on pipeline conversion and a recovery in regional markets.
* AI revenue grew 19.2% QoQ to USD3.1b on an annualized basis, crossing 10% of total revenue (Exhibit 3), while non-AI revenue declined sequentially. With AI-led productivity gains continuing to create deflation in traditional services, we believe the revenue impact from AI-led deflation continues to outweigh the incremental revenue opportunity from AI, limiting the near-term growth benefit.
* Margins remained flat QoQ at 24% despite continued investments in AI capabilities, hiring, and partnerships, with higher subcontracting costs also reflecting near-term skill gaps and visa-related constraints. With MHP expected to dilute margins by ~50bp in 2HFY27, alongside furloughs and continued investments, we lower our FY27/FY28 margin estimates and build in 24.3%/24.7%, respectively.
Valuation and view
* We expect USD revenue/EPS to compound at ~2%/~5% over FY26-28. International growth saw an improvement in 2QFY27, with growth broadening across key geographies and verticals, while deal activity remained stable. Demand is expected to remain selective, with growth likely to be driven by specific pockets as AI adoption continues to shape spending priorities. We have lowered our margin and EPS estimates for FY27/FY28 by 40bp/20bp and 1.6%/1.5%, respectively, reflecting continued investments in AI capabilities, hiring and partnerships, and higher subcontracting costs. We reiterate our BUY rating with a TP of INR2,400, based on 15x FY28E EPS, implying ~16% upside
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