Indian IT companies have been under pressure to return excess cash on their books to shareholders through generous dividends and buybacks
One of the news releases that set the markets abuzz this week was about a potential buyback of shares by TCS. TCS mentioned in a regulatory filing that its board will discuss a buyback of its equity shares on Friday.
The Economic Times reported that in the course of a fourth quarter earnings call, CEO Rajesh Gopinathan spoke about the company's proposal to “keep capital return close to 80-100% of annual free cash flow.” Just last year, TCS had carried out a 16,000-crore buyback for 5.61 crore shares, or ~3% of its total equity, at a price of 2,850 rupees per equity share. That process saw Tata Sons tendering over 3.6 crore shares, or around 64% of the overall buyback. The Government of Singapore, Copthall Mauritius Investments Ltd and EuroPacific Growth Fund were the other large investors who participated.
As of yesterday, TCS did not disclose details of its buyback, including the size of repurchase and the price at which it will buy shares. Media reports indicate that the buyback could be in the range of Rs 10,000 crore. Last fiscal, TCS made a 118 percent payout and this time around, as mentioned earlier, the company is looking at 100% buyout, and 80% at a minimum.
Why the buyback? Indian IT companies have been under pressure to return excess cash on their books to shareholders through generous dividends and buybacks. Share buybacks typically improve earnings per share and return surplus cash to shareholders, while also supporting share price during periods when market condition are sluggish. For FY18, TCS returned around 26,800 crores to shareholders in dividends as well the previous buyback. For the full year, TCS' net cash from operations stood at 28,160 crore rupees and free cash flow was Rs26,360 crores.
Some analysts say a buyback is more tax efficient. The dividend tax is quite high. “Already the management has said that every year 100% of the free cash flows will be returned to shareholders,” says Madhu Babu of Prabhudas Lilladher.
Besides TCS, Many IT firms including Infosys and HCL had undertaken buyback schemes last year. Infy’s buyback was around Rs13,000 crore while HCL’s was approx. Rs 3,500 crore. Cognizant plans to return $3.4 billion to its shareholders over the next two years through share repurchase and dividends.TCS, Infosys and Wipro, combined, returned $9.75 billion to its shareholders to keep investors’ faith amid the slowing growth. The three together hold over $12 billion in cash. They generate about $7.5 billion of cash every year, leaving them with enough cash to reward shareholders.
Today, the company’s stock opened at the Rs 1,815 level and touched an intra-day high of 1830, rising 2.75% in early trade. At 10:34 am on Wednesday, the stock was trading 2.04% or 36.30 points higher, at 1817 levels. BY 2.33 pm, the share was trading at Rs 1,826.95 apiece, not too far away from a 52 week high of Rs 1837. It has been gaining for six days and rose 5.50% during the period. Overall, the stock has clocked 48% returns during the last one year, and has gained 34% since the start of 2018.
“For FY19, we have factored total pay-out of Rs 23,900 crore, in-line with TCS’s outlook for a pay-out of 80%-100% of FCF,” said Urmil Shah, research analyst at IDBI Capital. He added that he sees “…a high probability of the quantum of buyback in this year being at least at the same level as in FY18 or Rs 16,000 crore. If the buyback is done at Rs1800 (which is closer to the CMP of Rs1,781), TCS would be able to buy back 2.32% of its outstanding shares.” IDBI Capital has maintained a positive outlook on TCS. It forecasts that TCS will deliver the best Year-on-Year improvement in revenue growth in FY19 amongst large-cap firms.
According to The Financial Express, Motilal Oswal Securities has a ‘neutral’ rating on the stock of TCS with a target price of Rs 1,500 per equity shares which implies a downside of 16% from the current market price of Rs 1,781.
Some analysts claim that this fiscal’s buyback, unlike last year’s, is likely to benefit promoters and institutions more than retail investors. Madhu Babu, Research Analyst - Institutional Equities, Prabhudas Lilladher, claims last year was a different scenario. He said, “When they started the buyback (last year), the sentiment on IT was very low and pre-split, the stock was around Rs 2200. They gave a buyback at almost Rs2850-2900. So, there was a lot of participation for retail and retail investors made good money. This year, the scenario is completely different…this stock is at 37% and the valuations are very full. TCS at 22 PE on FY20 earnings, is one of the costliest stocks. …compared with Accenture, it is now…trading at par with a billion dollar market cap.” Madhu Babu expects the premium to be very modest and says the buyback could most likely help the promoters.
Morgan Stanley has maintained an overweight rating on TCS but raised the 12-month target price to Rs2,010 from the earlier price of Rs1,825. That is a 12% upside in the next 12 months. Morgan Stanley expects EBIT margins can move toward 26-28 percent. The investment bank raised EPS estimates by four to five percent to factor in gains from the rupee’s depreciation. It cited an improved macro environment and strong execution as key near-term growth drivers for the TCS. "With the global growth, which is likely to remain strong, the U.S. economy doing well, broader and deeper digital adoption, and the rupee depreciating, we see several tailwinds for the stock,” said a note from Morgan Stanley to its clients. The noted added that the bank believes “…TCS is well positioned to benefit from possible increases in IT budgets, long-standing relationships with customers and strong investments in the business.”Last evening, TCS’ stock closed higher following reports that it had expanded its partnership with M&G Prudential. The bluechip IT company had announced yesterday that it expects to generate $1.36 billion in revenue over the next 10 years from its partnership with M&G Prudential. The new contract will cover 5.8 million policies and TCS claimed it stands to earn $668 million in business from the Prudential unit. This is in addition to the $690 million order it won from the UK insurer back in January. A Moneycontrol report observed that this partnership will boost TCS' position as the market leader in UK life and pension administration, with more than 18 million policies being administered by its banking and financial services or BFSI digital platform.