Tata Consultancy Services' Q2FY20 results (Neutral) - Not immune to sector growth and margin issues
Q2FY20 result highlights
- Materially below expectations on growth and margins: TCS posted CC revenue growth of 1.6% q-q (~100bps miss versus our/consensus est.), with EBIT margins down 20bps q-q to 24% (vs our/consensus est. of 24.8/25.3%).
- Large segments underperform on growth: The growth miss was driven by weakness in North America (their largest geography) which posted ~5% y-y growth and BFSI/Retail and Technology verticals (~55% of revenue), which posted below company average growth.
- Weakening margin trends seen at INFO repeat at TCS: TCS too is seeing similar trends as INFO on 1) Sub-contractor expenses rising 2) hiring growth (9.6% y-y) exceeding headcount growth (8.4% y-y in CC) as utilizations peak out and 3) Sector wide issues of legacy drag impacting margins. TCS EBIT margins fell 250bps y-y.
Key positives: Deal wins of USD6.4bn (best in last 6 quarters versus previous peak of USD6.2bn), strength in life sciences and communications and dividend pay-out of INR45 per share.
Key negatives: Miss on growth and EBIT margins, weak 2H outlook on continued sluggishness in BFSI/Retail and Digital (~1/3rd of revenues) growth slowing to 9 quarter low of 27.9% y-y (versus 42.1% in 1Q)
Impact on financials: Near 1.5-2% cut in FY21/22E EPS driven by ~2% cut in FY20/21/22E revenues.
Valuations and View
We expect TCS to react negative to results and retain Neutral on 1) Caution on 2H growth and BFSI/Retail (~46% of revenue), likely resulting in weak exit in 4Q and risks to consensus growth in FY21E 2) Skew towards UK/Europe for growth, where we are cautious given weakening macro and concentration of demand issues (BFSI/Auto/Brexit), 3) Less conviction on material margin recovery in absence of INR depreciation support and 4) Likely moderation in multiples as growth/margin outlook weakens and macro concerns weigh. We build ~7% USD revenue/EPS CAGR over FY19-22E, with EBIT margin decline of 170bps to 23.8% by FY22E. Our new TP of INR2060 (vs INR2150 earlier) is based on 21x 1 year forward EPS upto Sep-21E of INR97.9. Our target multiple is one notch lower to account for weaker growth and margin outlook, amidst higher macro uncertainty. HCLT and INFO remain our top Outperformers in large cap IT.
Tata Consultancy Services provide consulting-led integrated portfolio of information technology (IT) and IT-enabled services delivered through a network of multiple locations around the globe. Co.'s full services portfolio consists of IT and Assurance Services, Business Intelligence and Performance Management, Business Process Services, Cloud Services, Connected Marketing Solutions, Consulting, Eco-sustainability Services, Engineering and Industrial Services, Enterprise Security and Risk Management, Enterprise Solutions, iON -Small and Medium Businesses, IT Infrastructure Services, Mobility Products and Services and Platform Solutions.
IDFC Securities Ltd., a subsidiary of the Infrastructure Development Finance Company (IDFC) wherein the Government of India holds a 20% interest, is India's leading equities broker catering to most of the prominent financial institutions, both foreign and domestic investing in Indian equities. A research team of experienced and dedicated experts ensures the flow of critically investigated stock ideas and portfolio strategies for our clients. Our coverage spans across various growth sectors such as agriculture, automobiles, Consumer Goods, Technology, Healthcare, Infrastructure, Media, Power, Real Estate, Telecom, Capital Goods, Logistics, Cement amongst other sectors. Our clients value us for our strong research-led investment ideas, superior client servicing track record and exceptional execution skills.
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