TCS Group - Time to Stick or Twist?

As TCS's share price marches higher, it is incredible to recall that just nine months ago, a principle agreement valuing it at about $27.64 per share had been struck with Yandex. Now at triple that level, is TCS still a BUY? In our April report, we outlined why we think TCS has an excellent long-term investment case. We moved to a SOTP valuation and, with the stock having blown through our target price, is it time to stick (cut to HOLD) or twist (keep a BUY)? > Investments and SME deep dives highlight growth potential in non-banking businesses. The Investments and SME verticals strategy sessions may have focused on two very different business segments, but a couple of key unifying factors stood out. First, TCS has developed a great product in both lines, and, second, there remain huge potential organic growth and market share gains up for grabs over the next few years. In Investments, on top of the ongoing secular shift in savings habits, TCS has first-mover advantage, and relatively untapped areas of growth such as asset management. In SME, TCS is only just beginning to tap into larger companies and to leverage its greatly expanded Tinkoff Black customer base (just 4% of whom have Tinkoff Business accounts). We now raise our revenue expectation for both segments: we expect a 44% 2021-23 revenue CAGR for SME (versus above 30% guidance) and R50 bln Investments revenues in 2023 (versus above R40 bln guidance). We see each vertical contributing 14% to pre-tax earnings in 2023. > Cross-selling into growing customer base to keep driving revenue growth. TCS had over 10 mln active customers as of 1Q21, which is still not much over 10% of Russia's active banking population. We think by end-2023 it is on track to have over 18 mln active customers, and cross-selling within the ecosystem has only just started (with only 1.5 products per active customer). We see the number of revenue-generating products more than doubling over the next three years from 15.4 mln in 1Q21 to 33.5 mln at end-2023, and pre-provision revenues growing at a 22 CAGR in 2021-23.> Earnings momentum can support multiples. TCS's P/E expansion over the past year has come against a backdrop of strong consensus earnings upgrades, but 2022-23 consensus earnings now look fairly robust (we are +1% and -1% off consensus), which suggests further multiple expansion may be challenging. The question is now whether TCS can sustain the current multiples. We think this is feasible given we see consistent earnings momentum for 2022 and 2023 (26% and 23% EPS growth, respectively). Hence, even without further re-rating, the earnings outlook suggests that decent upside remains. > Monitoring the risks. The regulator has reinstated pre-Covid higher risk weights for new unsecured lending from the start of July, and we wait to see how much growth slows in 2H21 from an annualized 27% y-o-y for the sector over the past three months. Even if it eases, unsecured leverage is quite high at 10.3% of GDP (with mortgages catching up fast at 9.2%), and retail credit quality and the regulatory response may come increasingly into focus over the next year. Elsewhere, we remain unconvinced by the plans for international expansion, although we have few details at this stage, but clearly the domestic battle for customers among Russia's online ecosystems is heating up. In that regard, the CBR's ecosystem regulation plan implies a possible 1 pp higher capital requirement for TCS (SIFI treatment), though the long schedule for implementation looks comfortable. > Assumption changes: Lifting 2021-23 EPS by 2-9%, 26% 2021-23 EPS CAGR. We refresh our numbers after the strategy sessions and in light of recent RAS data releases. We raise our 2021E gross loan growth to 44% (from 36%), which will primarily boost 2022 earnings. As mentioned, we also lift our revenue expectations in the Investments and Business verticals. This gives us 2-9% higher 2021-23E earnings, for a 26% 2021-23E EPS CAGR. We make small changes to our segment splits, with the non-consumer finance businesses now set to contribute 48% of 2023E profits (around 40% adjusted for insurance).> Refining our SOTP valuation, TP raised to $102 per GDR. We moved to a SOTP valuation in April, underpinned by our assumptions on the trajectory of several early-stage, high-growth businesses in the context of a post-Covid world, where technological change is driving major shifts in consumer behavior. We think the SOTP framework is a more logical way of thinking about valuing TCS's business than a traditional banking GGM valuation, though it is far from perfect. We are now mid-year, so we roll forward our target valuation date by six months (to average 2022-23E revenues/EPS). We also think that applying a 20-30% discount to the main non-banking valuation peers (XP and PagSeguro) is excessive given TCS's excellent delivery and profitability across its business lines and its comparatively attractive growth story, so we cut the discount in these business verticals to 10%. Adding in our raised earnings forecasts, we derive a $102 per GDR 12-month target price (up from $72), and we keep our BUY recommendation. > TCS valuation not overheated in fintech context. We don't think it's time to stick just yet. TCS now trades at about a 14 2023 P/E and at our 12-month TP would trade at a 16.7 2023 P/E. This level of multiples lies more or less in the middle of, on the one hand, GEM banks (7-8 2023 P/E) and, on the other, leading GEM investments and payments players (XP and PagSeguro, for example, trade on an average 25-26 2023 P/E). This adds some context to the current valuation. It is also useful to think about TCS's valuation in the broader fintech context. Kazakhstan's Kaspi.kz has a $19 bln market cap (versus TCS's $17 bln) on a very similar active customer base (both had 10 mln at end-1Q21), but has arguably a slightly higher EPS growth outlook (about a 30% 2022-23 CAGR versus TCS's 25%), but a more challenging domestic growth outlook further out. Meanwhile, during the latest fundraising round in 1H21, Brazil's Nubank was valued at $30 bln on just under $1 bln in 2020 revenues (versus Tinkoff's $1.6 bln) and remained loss-making, but of course it has seen phenomenal growth in customer numbers - 33 mln at end-2020, and now over 40 mln (total, not active), versus TCS's 15 mln at end-1Q21, which actually means that both have captured around 10% of their addressable populations.