MOSL: TCS (Neutral)-Strong demand but cost pressures evident

TCS: Strong demand but cost pressures evident

(TCS IN, Mkt Cap USD100.6b, CMP INR1888, TP INR2000, 6% Upside, Neutral)

• Sustained revenue traction but costs drive margin compression: TCS’ 3QFY19 constant currency revenue grew 12.1% YoY (our estimate: +11.7%), EBITDA increased 21.7% YoY (5% miss) and PAT grew 24.1% YoY (our estimate: +21%). Although revenue momentum was strong, EBIT margin shrank 90bp QoQ to 25.6% (our estimate: 26.7%), led by elevated costs in the US, as evident from the 70bp QoQ uptick in subcontractor expenses.
• Key comments – no let-off on demand yet: TCS cited that demand on the ground was very healthy and broad-based across regions and verticals. This was reflected in deals TCV of USD5.9b v/s USD5b in the previous two quarters, with healthy contribution from North America (USD3b+), BFSI (USD2b+) and Retail CPG (USD800m+). With respect to elevated onsite cost, TCS expects it to rationalize over a period of time via investments in training and also passing some of it to clients.
• Onsite costs – an industry concern: The trend of supply shortage was called out by a few companies in 2QFY19 (INFO, MTCL and HEXW), which cited challenges in demand fulfilment at onsite. TCS’ 3Q margin and comments imply that there is a risk of pruning in margins across the board, at least in the near term, and that the pressures could be more exacerbated for peers.