TCS' revenue growth and profitability over the next 12-18 months will be weaker than we earlier anticipated, says the rating agency
Mumbai: Singapore based S&P Global Ratings on Tuesday revised its outlook on Mumbai-based IT services giant Tata Consultancy Services (TCS) to stable from positive given the subdued global IT spending estimates.
The rating agency still expects TCS to benefit from its good market position, service delivery capabilities and leverage client relationships to tap on demand for emerging areas of digital and workplace solutions to mitigate the weaknesses.
“TCS' revenue growth and profitability over the next 12-18 months will be weaker than we earlier anticipated. We estimate global IT spending will contract by 4% in 2020, in line with our expectation of a 3.8% decline in global GDP because of the COVID-19 pandemic. We now expect TCS' revenue to rise 0%-1% in the fiscal year ending March 31, 2021, compared with growth of 5.3% in fiscal 2020," said the agency in a report.
Hard-hit sectors such as retail, travel, hospitality, and media will take more than two to three years to recover to pre-pandemic levels. These sectors together contributed about 22% of TCS' revenue in fiscal 2020. Infection rates in key markets such as the U.S., TCS' largest client market (about 50% of fiscal 2020 revenue), remain high and pose further downside risks.
S&P anticipates pricing pressures on new contracts and renewals because of the lower spending ability of clients in a highly competitive market. At the same time, TCS' investment in onsite resources will continue, given persistent protectionist sentiment in global markets.
“The stable outlook reflects our view that TCS will maintain its good competitive position, robust cash holdings, and strong operating cash flows over the next 12-24 months. We also expect the company to pursue conservative financial policies toward acquisitions and shareholder distributions," S&P Global said.
This will keep the company's margins range-bound at 25%-27% in fiscals 2021 and 2022, compared with 27%-28% in the past two years. Demand for discretionary IT software and services is likely to remain weak in the coming quarters as clients look to trim budgets to conserve liquidity. Moreover, the pace of recovery will vary significantly across industry verticals and geographies.
Even so, TCS will likely maintain its industry-leading EBITDA margins because of its cost advantage on offshore resources and good service delivery capabilities, noted the agency. “However, achieving a better business mix with a higher share of revenue from new-age digital services--similar to its stronger global peers--remains challenging in current operating conditions. As such, an improvement in the company's business position commensurate with an 'a+' credit profile will take longer, in our view," said the report.
TCS' financial policy on acquisition spending remains conservative. The company had zero debt as of June 30, 2020. This allows the company to maintain a strong balance sheet despite sizable shareholder distributions, said S&P.
“Given the uncertain business environment, we expect TCS to remain prudent in its capital allocation policy and maintain its robust cash position," the report added.
Ratings maybe negatively impacted if TCS’ operating efficiency weakens such that earnings before interest, tax, depreciation, amortization (EBITDA) margins fall materially and sustainably below 25%, or if the company's financial policies toward acquisitions and shareholder distributions turn aggressive such that its ratio of debt-to-EBITDA increases beyond 1.0x on a sustained basis.
Highly competitive industry conditions and a business profile that is narrower than that of higher-rated peers limit the possibility of an upgrade. An upgrade would require TCS to improve its business mix from new-age digital services while maintaining its strong profitability at around 30% said the report.
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