TCS: Solid performance, but valuation is the dampener

Global IT services major TCS kicked off the December quarter earnings season on a positive note with better-than-expected results.

The company reported revenue (₹42,015 crore) and net income (₹8,727 crore) that beat Bloomberg consensus expectations by 1-2 per cent.

The operating margin of 26.6 per cent also came in better than expectations and improved QoQ.

This would be viewed positively by the street as further confirmation of the scope that exists for the company to achieve margins in the aspirational 26-28 per cent band in the longer term.

Broad-based growth

Management commentary was also optimistic, highlighting broad-based growth – both across verticals and geographies.

The deal win momentum was also good, according to them. Given the uncertainty and challenges highlighted at the time of the first results update after Covid-19 (March quarter results), these pointers are a positive contrast.

While the company does not give guidance, the commentary indicates confidence on better performance looking ahead and achieving double digit revenue growth in FY22.

TCS is expected to close FY21 with revenue growth of around 3 per cent (will get revised marginally upwards after today’s results).

One thing to be noted is that while the December quarter sequential revenue growth is the strongest in nine years, this also has the positive benefits of base effect.

Broadly, the company has given much to be optimistic about for its future performance. Demand for digital transformational services remains strong and the company is well positioned to continue to capitalise on this as indicated by its results. Despite this, one needs to be cautious on stock given its valuation. The stock is up around 40 per cent in the last one year. This at a time when it is expected to close FY21 with flat to marginally higher earnings growth. The stock currently trades at around 31 times FY22 estimated EPS (Bloomberg consensus) . This is not cheap for a stock with moderate EPS growth.

According to a recent report by Credit Suisse, TCS’ EPS is expected to grow at a CAGR of 13.3 per cent in CY20-22. Its 5-year EPS CAGR from FY 15 to FY 20 was 10 per cent. It now trades at a level which is slightly more expensive than global leader in digital services — Accenture. For comparison, in the recently closed November quarter, Accenture reported over 8 per cent QoQ revenue growth vs TCS’ 5.1 per cent growth (in dollar terms).