What to do with TCS Share after Quater 2 result in FY 23 Expert Analysis..

Summary 

1. Revenues grew by 4% q-o-q and 15.4% y-o-y in CC terms ahead of our expectations of 3.1% q-o-q growth and street expectations of 3.5%.
2. Despite intensifying macro headwinds, management seems comfortable with on-demand visibility. Expect H2 to witness normal seasonality as seen in the earlier years owing to furloughs. Management remains watchful of the situation
3. EBIT margin stood at 24% vs our estimate of 23.6%, rising by 90 bps q-o-q. The beat was led by better operational efficiencies and productivity. As supply-side pressure is easing, management remains optimistic about achieving a 25% EBIT margin by Q4 FY2023.
4. We maintain a Buy on TCS given comforting demand commentary, the scope of margin improvement and undemanding valuations.

TCS reported revenue growth of 4% q-o-q and 15.4% YoY in CC terms ahead of our expectations of 3.1% q-o-q growth and street expectations of 3.5%. In USD terms, revenues were up by 1.4% q-o-q, owing to cross currencies impact of 290 bps. EBIT margin at 24% vs our estimate of 23.6%, an improvement of 90 bps q-o-q, the beat was led by better operational efficiencies & productivity, also partly helped by the depreciation of the Indian Rupee, whereas rising discretionary expenses, back-to-office expenses and cross-currency movements restrict improvements. Further, subcontracting costs stayed at 10% in Q2, higher than the average of 8.8% in the last eight quarters. Broad-based growth across verticals led by Life science and technology sequentially. Geography-wise growth was driven by North America, India and MEA, despite macro challenges. Deal TCVs wins moderated further sequentially, but steady at $8.1 bn vs $8.2 bn in Q1, in line with the long-term average. The book-to-bill ratio stood at 1.2x, in line with its long-term average book-to-bill ratio. Hiring drops q-o-q at ~9840 vs 14136 in Q2, total headcounts up 1.6% q-o-q, attributed to strong hiring in the past quarters (trainee turning productive), while attrition inch up to 21.5% (from 19.7% in Q1). Management expects attrition is peaked in Q2 and expects a gradual downtrend in the coming quarters.

Key positives.

Margins beat estimates despite supply-side challenges, led by operational efficiencies.

Revenue growth in CC term is much ahead of estimates, amid macro challenges

Key negatives.

Attrition inched up to 21.5%, 180 bps higher q-o-q. Hiring moderated q-o-q, total net hiring up 1.6% q-o-q. 

BFSI growth continues to lag average company growth, up 0.8% q-o-q Š Continental Europe continued to decline on q-o-q for the third consecutive quarter.

Management Commentary. 

 Despite growing macro headwinds, management seems comfortable with on-demand visibility. Expect H2 to see normal seasonality as seen in the earlier years owing to furlough.

 The US continues to witness strong demand visibility, with no caution as of now. However, the management expects some volatility in Europe and the UK. The insurance sector is witnessing weakness within the BFSI space.

The management remains optimistic about achieving a 25% EBIT margin by Q4 FY2023 as supply-side pressure is easing out and expect further productivity gains

TCS Ltd Stock Recommendation.

Increasing global macro uncertainties remain an overhang for demand visibility for the IT sector and would also restrict any meaningful valuation re-rating in the near term. Though the management remains watchful of the macro situation and does not see any material change in the client's behaviour. We are sceptical about the environment owing to the deteriorating situation, especially in Europe/UK. Nevertheless, we remain confident in the TCS's capabilities to withstand the macro challenges and emerge stronger. At CMP, the stock trades at a valuation of 26.9x/25/21.9x its FY2023E/FY2024E/FY2025E earnings. We continue to prefer TCS for the long term considering its best-in-class capabilities and execution, full-service model and excellent payout ratios.

TCS Ltd Stock Target Price.

We have a buy recommendation on the stock with a Target price of Rs 3650.CMP 3050.

Risk Factor.

Rupee appreciation and/or adverse cross-currency movements and/or constraint in local talent supply in the US would affect earnings. Further, macro headwinds and possible recession in the US are likely to moderate the pace of technology spending.