The near-term margin concerns drag TCS
PremiumA meaningful earnings upgrade for TCS would depend on deal-win momentum translating into revenue growth
Tata Consultancy Services Ltd (TCS) has ended FY22 on a strong note with the highest-ever order book of total contract value worth $34.6 billion. The March quarter (Q4FY22) earnings, too, met expectations with 3.2% sequential constant currency revenue growth.
TCS saw the highest-ever order inflow of $11.3 billion during the quarter, which included two mega deals of $1 billion each. Excluding these, its total contract value for Q4FY22 at $9.5 billion was still up around 3% year-on-year (y-o-y), the management said in a post earnings conference call.
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TCS continues to see strength in the demand environment and is confident of it continuing over the medium-term. Increasing outsourcing and cloud transformation would remain among key demand drivers for TCS.
However, investors aren’t excited and the stock was flat on NSE on Tuesday.
Near-term concern on margins persists. In Q4, earnings before interest and tax (Ebit) margin was flat sequentially at 25%, but a tad higher than the consensus estimate of 24.9%. Y-o-y, the margin slipped 180 basis points (bps), mainly because of supply-side pressures. One basis point is 0.01%. For FY22, TCS’s Ebit margin at 25.3% was 60bps lower than last fiscal.
Operating margin at 25% is lower than TCS’s aspirational margin band of 26-28%. TCS is working towards boosting its operational levers to achieve these levels, in the near-term margins are expected to remain volatile, cautioned the management.
Travel costs have also started to make a comeback, adding to rising manpower costs, it said. The company has also announced wage hikes, starting 1 April and the quantum is similar to that of the previous year.
Margin headwinds will stay in FY23 for the industry, though TCS is much better positioned to navigate the challenges, noted Kotak Institutional Equities.
“A meaningful earnings upgrade for TCS would depend on sustenance of its strong deal-win momentum and that translating into higher revenue growth. Second is if revenue growth further converges between TCS and Infosys, with the former doing better. Third is the pace of margin recovery. On the flipside, if the risks of recession play out in key markets of the US and Europe, the growth story goes for a toss," said an analyst requesting anonymity.
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In the last one year, the TCS stock has risen nearly 14% vis-à-vis a 29% gain in Nifty IT index. Bloomberg data shows that the TCS stock trades at 31.2 times estimated earnings for FY23 versus 27.6 times for Infosys, which is set to announce Q4 results today. “TCS’ premium valuation over Infosys, despite slower growth, may limit upside," said Jefferies India.