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MOSL : TCS: Strong growth and demand outlook key positive in Q2

TCS: Strong growth and demand outlook key positive in Q2

(TCS IN, Mkt Cap USD138.7b, CMP INR3121, TP INR3580, 15% Upside, Buy)

Stable deal TCV to allay concerns on near-term growth

• TCS reported revenue of USD6.87b in 2QFY23, up 4.0% QoQ in constant currency (CC) terms, 50bp above our estimates. The company reported deal wins of USD8.1b (up 7% YoY/flat QoQ, book-to-bill ratio at 1.2x), in line with its historical trajectory.
• EBIT improved 90bp QoQ to 24% (vs. our estimate of 23.5%) despite supply pressures. Lower employee expenses, operating leverage, and lower sub-contractor expenses aided margins in 2QFY23. LTM attrition jumped 180bp to 21.5%. The management has indicated that quarterly annualized attrition should moderate starting 3QFY23.
• Management commentary on the demand environment and deal pipeline remained intact with no visible impact of weakening macro environment; however, the management has indicated risks to deal pipeline and conversion in Europe due to uncertainty around energy prices. TCS is seeing some caution for longer term deals and is experiencing some delayed decision making in Europe, but it continues to see a strong spending environment in the US. While the optimistic commentary was on expected lines, we remain concerned on the near-term growth due to macro slowdown. We are factoring in USD revenue growth of 7.5% YoY in FY23, owing to the macro headwinds in the second half of the year along with elevated cross-currency headwinds.
• The margin (up 90bp QoQ) was better than expected on account of lower employee costs, sub-contractor expenses, and operating leverage. The management indicated that attrition has peaked out and quarterly attrition should ease in the coming quarters. The supply situation easing out in 2HFY23 along with benefits from increased fresher additions in the last few quarters and lower sub-contractor costs should aid margins. However, we remain concerned about Q3 margin due to the timelines of cost optimization strategies. We expect the margin to improve in 2HFY23 and hit exit run-rate of ~25%. We expect FY23/24 margin to be at 24.1/24.8%.
• We have slightly tweaked our FY23/FY24 EPS. We expect a USD revenue CAGR of 8.1% over FY22-24 and INR EPS CAGR of 13% during the same period (aided by INR depreciation). Our TP of INR3,580 implies 27x FY24E EPS, with a 15% upside potential. We reiterate our Buy rating on the stock.

Good topline growth, margin improvement led by lower employee cost

• Revenue (CC) grew 4.0% QoQ, INR EBIT/ PAT rose 11%/8% YoY in 2QFY23.
• EBIT margin of 24% (up 90bps QoQ) was above our estimate of 23.5%, led by lower employee costs.
• The company added 9.8k associates, the lowest net adds in the last nine quarters.
• TCS announced a dividend of INR8/share.