Madhuchanda Dey Moneycontrol Research
Tata Consultancy Services (TCS) delivered in-line performance in Q3FY19. Expect modest returns going forward as global macro concerns, supply constraints in delivery and heady valuation partially masks the strong demand environment.
Key Positives
Double-digit growth (12.1 percent YoY) in Constant Currency. Digital continues to impress with a share of 30.1 percent and reporting strong YoY growth of 52.7 percent.
Growth is seen across geographies led by UK, Continental Europe and Asia Pacific. The key market of North America, with a share of over 51 percent, has also shown a good 8.2 percent growth YoY.
Traction in key verticals with BFSI growth improving to 8.6 percent from 6.1 percent in the September quarter is aided by the North American market and insurance vertical. Life sciences, energy and utilities and regional markets continued to impress.
Strong deal win momentum with value of deal wins at $5.9 billion — 20 percent growth over the previous quarter and positive commentary on deal pipeline and demand environment.
The TCS management stressed on their strong expertise in areas of digital, IoT (internet of things), AI (artificial intelligence) and intelligent automation as drivers for deal wins and hinted at a shift in preference for outsourcing by larger companies, contrary to fears of insourcing (where companies prefer to do the job in house) on the rise.
Key Negatives
Decline in operating margin sequentially by 90 basis points to 25.6 percent on negative currency impact and rising costs especially sub-contracting expenses.
The management alluded to supply side constraints (getting the right resource at the right price especially in light of increasing visa restrictions) which is likely to exert upward pressure on costs.
TCS is keen to participate in the buoyant demand revival and feels that it has headroom to absorb higher cost as its operating margin is higher than most peers.
Key Observations
The supply side constraint is an industry wide phenomenon and is likely to impact all players. In fact, smaller companies might find it more challenging. A price hike to offset this impact is possible especially if demand remains strong, but could happen only with a lag.
The management is unsure about the impact of recent macro concerns —weakness in global economy on account of heightened trade tensions — on the demand environment and has not seen any slowdown in the market yet.
Outlook
While TCS stock has outperformed (42 percent against 4 percent for the Nifty) in the past one year, the performance in the past three months was soft. TCS trades at 20 times FY20 estimated earnings. We expect modest return from the stock in the medium term and recommend accumulation only on correction.
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