Why TCS missed Q2 targets

Tata Consultancy Services (TCS) reported weaker than expected Q2FY20 on both revenues and margins. The increasing complexity of deals, the impact of e-commerce on IT spends by traditional retail players in the US and higher costs related to hiring locally are weighing on the IT company, according to analysts.

“Though order intake was at a six-quarter high, including in the BFSI vertical, increasing the complexity of deals is driving a slower conversion into revenues. Deal sizes are increasing but so are deal durations, which again skews the revenue conversion,” said analysts at ICICI Securities.

TCS reported a disappointing performance in 2QFY20 with USD revenue growing by just 0.6 per cent to $5.51 billion. Poor Retail performance (-0.8 per cent QoQ in USD terms) was one of the reasons that led to the revenue miss. “Retail vertical saw orders getting pushed out, a reflection of stress partly due to the Amazon effect and the continued closure of retail stores in the US,” said analysts at Reliance Securities.

This is the second successive quarter when the IT major has missed estimates on both revenue and margin.

Read also: TCS may miss double-digit growth target this fiscal

Lower revenue from the UK (-0.7 per cent) and India (-4.4 per cent) dragged its overall revenue. Service-wise, digital revenue rose 3.7 per cent QoQ in USD terms (slowest sequential growth since 2QFY17), while YoY growth decelerated to 25 per cent (slowest since 4QFY17). Digital services contributed 33.2 per cent to total revenue in 2QFY20 compared to 32.2 per cent in the previous quarter.

“Continuing from 1QFY20, the management called out incrementally cautious commentary led by weak BFSI outlook and worse-than-expected Retail headwinds. The current quarter will see similar trends as well. In such an environment, double-digit growth is a mirage and growth expectations must be watered down, particularly in the context of slowing (albeit still healthy) Digital growth,” said a report from Reliance Securities.

“ While TCS continues to see healthy orders, conversion to revenue is taking time, partly due to participation in clients’ digital journeys and rising deal sizes leading to the involvement of more executives in decision-making,” it added.

Margins were weaker on capacity creation as TCS inducted 30,000 campus hires in H1FY20 and should recover going forward but are expected to remain lower than prior expectations.

Large banks across the US and Europe and capital markets segments continue to be the principal sources of weakness. EBIT margin declined by 20bps QoQ to 24 per cent . Employee cost within Selling, General & Administrative Expense (SG&A), which captures bench for TCS has increased by 90bps to 13 per cent of revenues from 12.1 per cent in Q4FY19 driven amongst other things by the induction of 30,000 freshers in H1FY20. Overall headcount increased by 3.2 per cent QoQ in Q2FY20 with a net addition of 14,097 employees being highest ever in a quarter,” said ICICI Securities. The build-out of the offshore bench as the industry continues to see increased offshoring also added to the pressure.

“September’19 quarter confirm the risks to the company’s earlier suggested outlook of double-digit growth, and we would reckon that the street will align FY20 revenue growth to <9% YoY constant currency growth post these results,” said Emkay Research.