Stock Fundamentals

Why TCS is a good bet despite its premium valuation

Vivek Ananth | Updated on August 23, 2020 Published on August 23, 2020

The worst may be over and revenue can stabilise from the second half of this fiscal

After the pandemic-induced mayhem in the market in March, some sectors have seen stock prices rebound from their lows.

IT services stocks in general and Tata Consultancy Services (TCS) in particular have seen this trend play out.

TCS’ revenues took a considerable hit in the quarter ended June 30, 2020. The company says that the worst impact of the pandemic on revenues is over, and revenues will stabilise from the second half of financial year 2020-21. However, there may be some impact on revenues owing to the lockdowns across the world. This can affect clients’ willingness to spend, though technology spends have become essential in the physically distanced way of doing business.

TCS is India’s top IT services exporter. The company bagged nearly $6.9 billion worth of new deals in the April-June 2020 quarter, which is over 20 per cent higher than that in the same quarter in 2019-20

Expectations of sound revenue and earnings growth have led the rally in the stock. TCS currently trades at a 12-month trailing price to earnings (PE) multiple of 27 times, higher than its three-year average PE of 24 times.

The market is continuing to ascribe a premium to TCS’ valuations compared with its peers Infosys and HCL Technologies.

The pricey valuation could limit the upside in the stock in the near term. Investors can hold on to the stock.

Financials

TCS’ revenues took a big hit in the quarter ended June 30, 2020.

In dollar terms, revenues fell 7.1 per cent quarter-on-quarter to $5.06 billion. In rupee terms, revenues declined 4.2 per cent to ₹3,83,220 crore.

The consolidated net profit during the quarter fell nearly 15 per cent on a sequential basis to ₹7,080 crore. On the operating margin front, the company saw a 150-basis-point (bps) contraction during the April-June 2020 quarter to 23.6 per cent.

This was owing to the fall in revenue and discounts sought by clients. Flat employee costs and a marginal decline in sub-contracting costs, apart from the weakening rupee, supported TCS’ margins in the quarter ended June 30, 2020.

The company says it expects margins to improve going ahead. However, it needs to be seen if the firm is able to achieve its aspirational operating margin band of 26-28 per cent

Operating factors

The company’s revenues from the UK have been severely hit because of the twin impact of Brexit and the pandemic. There is uncertainty over the situation in the region. However, the monetary stimulus in Europe and the US (which make up for 70 per cent of revenue) has helped cushion the blow. US revenues fell 5.3 per cent sequentially to $2.7 billion in the June quarter, while revenues from Europe fell by 4.6 per cent. The company managed to increase the number of customers from whom it earns revenues of $100 million or more to 48 in the April-June 2020 quarter from 44 in January-March 2020.

The deal pipeline and the projects it has bagged will aid revenues in the coming quarters.

Verticals such as manufacturing were severely impacted due to negligible manufacturing activity, so were retail and consumer packaged goods because of stores were. Life sciences and healthcare was the only vertical that saw a sequential revenue rise. This vertical will be the fastest to pick up in terms of revenue growth.

Banking, financial services and insurance (BFSI), the company’s mainstay, was not impacted much due to government support given to banks in Europe and the US. The continuing fiscal and monetary support in these geographies should aid revenues from BFSI. However, the risk to watch out for is bankruptcies and continuing low interest-rate environment that will impacts client spends.

For now, faster migration to digital and cloud adoption will continue to provide revenue boost for TCS. The company can gain market share, and participate in the vendor consolidation exercisehappening across the board.

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Published on August 23, 2020
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