TCS did well in Q4, but its shares bear the weight of higher expectations

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 2 min read . Updated: 13 Apr 2021, 05:44 AM IST Mobis Philipose

Shares of Tata Consultancy Services Ltd (TCS) are about 45% higher than their pre-covid highs of February 2020. In covid-hit financial year 2020-21 (FY21), the company’s revenues declined 0.8% in constant currency terms. Evidently, investors are pricing in a jump in growth in the future, starting FY22.

Indeed, TCS reported a 17% jump in deal wins in the previous financial year, which along with a relatively low base is expected to boost growth this fiscal year.

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However, with the company’s shares having risen far ahead of its pre-covid peak and valuations of more than 30 times one-year forward earnings, investors are banking on high growth for some time to come.

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TCS’s average annual growth three years before covid was at 7.8%, but the current share price assumes annual growth of around 12% for the next 10 years, analysts at Ambit Capital point out. IT companies such as TCS have done their bit with building such expectations with statements that the change in demand trends post-covid is a multi-year shift.

All of this sounds good. However, investors need to face the fact that TCS’s latest results don’t provide any reason to upgrade their estimates. If at all, current growth expectations should be tempered a bit.

In constant currency, revenues grew 5.9% year-on-year (y-o-y) in Q4, with a couple of verticals still showing negative growth.

The growth was aided by the ramp-up of some recent large deal wins.

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“The results might be a tad disappointing given the strong run-up in the stock ahead of results and will limit any material raise in FY22/23 EPS estimates. We would expect a mildly negative reaction to the results in a trade tomorrow on a prima facie basis," analysts at JM Financial Institutional Securities said in a post-results note to clients.

Margins continue to be higher y-o-y, but are expected to come off in this fiscal as some pandemic related cost savings fade away and with wages expected to rise faster.

“We continue to see 2 wage hikes across most companies over a 3-4- quarter duration, expect attrition bump-ups and sharp pick-up in hiring with possible moderation in utilization across companies. This coupled with a likely partial reversal of one-off benefits like travel, sub-contracting and discretionary spends in 2HFY22E makes us cautious on sector margins," analysts at Ambit said in a 1 April note.

Indeed, while hiring was sluggish about a year ago, it has picked up to record levels now and the competition for talent is expected to affect margins for the sector. The increase in hiring also reflects fairly strong growth expectations. And TCS has done fairly well to bounce back from the impact of covid in the first half of FY21, even though it has lagged peer Infosys Ltd. The sequential growth in Q4 was also ahead of historical trends.

But while the performance is decent, the stock has run far ahead of itself.

Based on March quarter revenues and assuming zero sequential growth, TCS will report revenue growth of 8% y-o-y in FY21 given the low base.

With some incremental growth, revenue growth will be comfortably in double digits, though if margins come under pressure, growth in core earnings will be nowhere near the high levels needed to justify the more than 30 times valuation of the stock.

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