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MOSL: TCS (Neutral)-Near-term less certain- medium term more reassuring

TCS: Near-term less certain; medium term more reassuring

(TCS IN, Mkt Cap USD116.0b, CMP INR2131, TP INR2100, 1% Downside, Neutral)

 

• Kick starts the year on expected lines: TCS' revenue growth deceleration (10.6% YoY CC in 1QFY20 on the base of 12.5% in 4QFY19) and EBIT margin contraction (-150bp QoQ/- 90bp YoY to 24.2%) were both in line with our estimates. PAT grew 10.8% YoY to INR81b, implying a 6.2% beat, helped by higher other income and lower ETR (23.4% v/s our estimate of 24.2%). Adjusted for the accounting changes toward leases (~INR1.18b), the EBIT margin would have been 23.8%, marginally below our estimate. TCS signed deals totaling USD5.7b in 1QFY20 v/s USD4.9b in 1QFY19 and USD6.2b in 4QFY19. Aggregate book-to-bill of the last four quarters stands at 1.06x.
• Capital markets drag, Retail softness transient: TCS had indicated at the beginning of the year about pockets of weakness in Capital markets within BFS. Revenue growth in both BFSI (9.2% YoY CC) and Retail (7.9% YoY CC) decelerated by 200bp+ compared to the previous quarter. Retail was hit by some unexpected acceleration in closures, and should improve starting 2QFY20. Two verticals grew in double digits - Healthcare & Life Sciences (+18% YoY CC) and Regional markets & others (+17% YoY), together constituting 29.4% of revenue.
• 2Q will determine plausibility of double-digit growth: TCS cited that the 1Q performance turned out to be lower than anticipated, as weakness in BFS was more pronounced. Ability to attain double-digit growth in FY20 now hinges on a crucial 2Q, as it will be tough to make up for the shortfall in a seasonally weak 2HFY20. In contrast, TCS saw the best net employee additions in five years, with offers to 30k campus graduates, who will be on-boarded by 2QFY20 itself. This is in the wake of the positive medium-term demand outlook, and TCS' ability to train a much higher number of trainees, having reimagined its processes with Technology's aid.
• Valuation view: Our estimates remain unchanged after an in-line performance in 1QFY20. The certainty factor around double-digit FY20 growth has waned with hopes now pinned on 2Q, casting doubts on the traction in the near term. Margin base in 1Q and the continued rise in subcontractor expenses hint at higher pressure on earnings growth this year. Demand environment for the medium term remains healthy, and hiring numbers at TCS induce confidence toward that end. We expect USD revenue/EPS CAGR of 9.8%/9.6% over FY19-21. Our price target of INR2,100 discounts forward earnings by 20x. Maintain Neutral.