TCS: No worsening of demand; deal activity healthy

15 Sep 2023 , 10:16 AM

Recommendation: Buy; Target Price: Rs 3600

Analysts of IIFL Capital Services met with TCS management to get an update on the state of the IT demand environment. They reiterated that their deal pipeline and conversions remain healthy as reflected in the strong order book; however, the overall IT spending has been slow and there is no material pickup in volume growth. The ramp-up of large deals is going as planned, which should support revenues during the rest of the year. Muted headcount growth is a reflection of reduced utilisation, led by spending cuts; but also offers a big lever for margins once the growth picks up. Capital allocation policy remains unchanged and TCS has returned ~100% PAT in the past six years. Historically, half of that cash was given out through buyback, if the window is available in any financial year. Analysts of IIFL Capital Services forecast 8%/12% USD revenue/EPS Cagr over FY23-25 and maintain BUY, as they see better resilience in growth and margins for TCS vs peers. 

Overall demand remains muted though new deals continue to flow: TCS reiterated that the demand environment remains muted, as some of the projects from the post-pandemic period have not seen follow up on spending amid the continuing uncertainty on macro. However, new deal awards have stayed healthy and deal ramp-ups have been on track. At the same time, it is difficult to say when the overall growth will sustainably pick up. 

Mixed trends across verticals and geos: TCS indicated that BFSI, Telecom, Hi-tech and parts of Retail continue to witness moderate growth; while Manufacturing (due to large deal ramp-ups) and parts of Retail (due to Travel and Hospitality) remain more resilient. While the Americas and Continental Europe remain under pressure, the outperformance in UK is driven by years of tech underinvestment in the country post-Brexit, which is resulting in better spending, and TCS is at the centre of enabling it for many UK customers. 

Easing supply side to support margins as growth picks up: TCS believes that attrition could reach normalised levels by 2HFY24. This year, net hiring has remained muted, even though TCS would honour all fresher offers. This would ensure that utilisation improves as there is enough builtup capacity; however, that could be gradual. But, this provides significant margin tailwind once the revenue starts growing faster. BUY