TCS Plunged on Muted Guidance and Tata’ Air India Acquisition; What’s Next?

  • Stock Market Analysis
  • Editors Pick

TCS (NS: TCS ) stumbled over -13% in the last 2-weeks since its Q2FY22 report card, which was below market expectations. TCS was also dragged by Tata’s Air India acquisition as being a ‘cash cow’ for Tata, the market is also concerned that TCS may eventually bail out Tata Sons for this ailing Air India business, especially in COVID times, where international travel is not normal and there are issues with India’s vaccine certificate (vaccinations quality) with other big countries; especially AEs like U.S., Canada, and Europe.

The market is concerned that Air India is a sentimental acquisition by Tata rather than pure commercial and thus, being a positive cash-flow company, TCS has to eventually shell out some cash for Air India until it turns profitable. But the positive factor is that Air India has a near-monopoly for International travel among Indian companies and hopefully it will be able to compete profitably with other international competitors despite skyrocketing ATF prices.Talace Pvt Ltd, a unit of the holding company of Tata group, made the winning bid of Rs 2.7B cash and Rs 15.300B in debt takeover for Air India.

The TCS CEO Gopinathan said Air India is a nostalgic airline for most TCS employees and the company will offer its complete support in whatever form it can, to contribute to the revival of the airline to its former glory:

"Air India is quite a nostalgic airline for most TCSers. Almost all of us took our first international trip on Air India, and we used to go with this return ticket, and that used to be our safety guard that if all else fails, we just have to get to an Air India office somewhere, and we'll get back home. TCS will do its best to contribute in whichever form we can, to revive it (Air India) to the glory that it had as one of the best airlines in the world.”

Highlights of Q2FY22 report card (consolidated):

  • Revenue Rs.46.867B vs 45.411B sequentially (+3.21%) and 40.135B yearly (+16.77%); estimate 47.466B
  • Revenue growth in CC (constant currency) +15.5% and USD +16.8% (y/y)
  • Total operating expense Rs.33.751B vs 32.748B sequentially (+3.06%) and Rs.28.622B yearly (+17.92%)
  • EBTDA (EBITDA-INTT); i.e. core operating profit Rs.12.974B vs 12.517B sequentially (+3.65%) and 11.339B yearly (+14.42%)
  • Core operating EPS Rs.35.06 vs 33.83 sequentially (+3.65%) and 30.24 yearly (+15.97%)
  • Core operating margin 27.68% vs 27.56% sequentially and 28.25% yearly
  • Operating (EBIT) +25.6% vs market expectations +26.05%; +0.01% sequentially and -0.6% yearly
  • Strong Client Addition: 5 New Clients (total: 54) in $100M+; 17 new clients (total: 114) in $50M+
  • Net Cash from Operations at Rs.9.945B; i.e. 103.3% of Net Profit Rs.9.624B
  • Net headcount addition of 19,690; Workforce strength: 528,748
  • Performance was helped by COVID-related boosts like techs for contactless payments, card-less withdrawal of cash from ATMs for leading banks, space-range-display transformation for retailers and cloud computing etc.
  • As per TCS, the operating margin +25.6% and net margin +20.5% inherently resilient despite industry-level inflationary headwinds (higher operating cost)
  • Upbeat performance from manufacturing, life sciences & healthcare, retail & CPG, and BFSI verticals
  • Revenue growth was led by North America, the U.K., continental Europe
  • The regional business was led by India, Latin America, the Middle East and APC
  • Portfolio of products and platforms performed well
  • The company performed well despite supply-side/labor shortage and cross-currency headwinds; except USD, all other currencies depreciated against reporting currency INR
  • FCF (Free Cash Flow) Rs.92.29B
  • Emphasis on the digital platform, AI, Machine Learning and Cloud computing; energy and financial market new growth area
  • Strong order book; TCV (total contract value) $7.6B; up by +25% after excluding one very large mega-deal for Q2FY21
  • Continue to pursue both inorganic and organic expansion with stress on R&D and innovation, which ensures core operating margin and pricing power despite an environment of deflation in the industry
  • Europe was soft amid COVID disruptions
  • Revenue growth for Q3FY22 may be around +4.0% under CC (constant currency)

Finally, the TCS CEO Gopinathan said:

We had strong broad-based growth across all our industry verticals and very strong deal wins yet again in Q2. Our client additions were very strong across all revenue buckets this quarter, an important measure of the depth of our customer relationships. Our margins continue to be industry-leading and have shown immense resilience despite supply-side challenges this quarter and currency headwinds. On the people front, by investing ahead of time in hiring the right talent across the world and onboarding a record number of fresh engineers, we have been able to overcome supply-side challenges and stay on track with all our execution timelines. Our attrition went up this quarter but continues to be the lowest in the industry. We are still watching this closely for the next few quarters. We have vaccinated 70% of our employees fully and over 95% have received at least one dose. This sets us up well to start bringing them back to the workplace towards the end of the year.

TCS is one of the largest Indian IT services companies. Like all other major IT service companies, TCS is also an export-heavy company; almost 95% of its revenue comes from outside India; over 52% of revenue comes from North America, while around 32% generates from Europe. TCS software/service is mainly dominated by BFSI (Banks, Financial Services, and Insurance), retail & consumer business (including CPG, travel and hospitality), communication, media & technology, trading & distribution and life science & healthcare. IT services: consulting and engineering services, solutions and systems integration, management applications development, outsourcing services, etc. Also, the sale of IT equipment and software licenses is a small part of the TCS business.

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TCS is now emphasizing reskilling; upskilling, innovations (R&D) and adapting itself to the changing world post-COVID. Like all big tech companies, TCS is also a prime beneficiary of the COVID lockdown-led digital world (WFH) and the part & parcel of ‘K’-shaped economic recovery post COVID world, unlike the consumer-facing service industry. But post-COVID, there will be less appeal of such a digital theme, although, in some areas, WFH may be a permanent feature for better productivity. Traditionally, TCS as well as other big Indian IT outsourcing companies are very conservative in guidance. Looking ahead, rapid COVID vaccinations, economic recovery in U.S. and Europe/U.K. and higher USDINR may help TCS and all other big IT outsourcing companies. TCS has robust deal pipelines (TCV) along with scattered large deals.

Bottom line:

Looking ahead, TCS is in a position to maintain/expand such a healthy operating margin amid higher utilization, better productivity (WFH), and increasing automation. This coupled with the company’s vision of transformation, emphasis on cloud migration and the global shift towards digital tech could help TCS in maintaining incremental growth in revenues. Considering all these factors and current/historical run rate, TCS may report core operating EPS around 147, 176, and 211 in FY22, FY23 and FY24 against actual FY21 figures around 122.42 (assuming 20% CAGR on an average). And assuming an average PE of around 20, the fair value for FY23/24/25 may be around 3400-4090-4908. As the market is now discounting FY24 earnings, TCS may scale around 4090 by Mar’22 and 4908 by Mar’23. TCS’ consistent organic revenue and operating margin above 27% may help.

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Technically, whatever may be the narrative; TCS has strong support around the 3450-3400 area, which may be a major demand zone for mid-long term investment purposes. The near-term target is around 4000-4100.

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TCS: P/L account analysis: Consolidated

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