VALUATION CONCERNS CLOUD TCS’ MARCH QTR PERFORMANCE

Stock falls over 4% on Tuesday despite matching estimates

Tata Consultancy Services’ (TCS’) strong March quarter (Q4) performance failed to impress Dalal Street and the stock tanked over 5 per cent to hit an intra-day low of ~3,074.55 apiece on the BSE Sensex on Tuesday. It recouped some of the losses to end the day down 4.21 per cent at ~3,105, but was the worst-performing Sensex stock.

The IT services major on Monday posted Q4 numbers largely in line with or above analysts’ estimates. Helped by demand for core transformation services, market share gains, and ramp-up of two large deals, TCS reported a 14.9 per cent year-on-year (YOY) jump in net profit at ~9,246 crore, as against the Bloomberg consensus estimate of ~9,268.6 crore. Meanwhile, revenue growth of 5.9 per cent YOY for the quarter under review to ~43,705 crore, beat analysts’ prediction of ~43,517.7 crore.

The company surprised on the margin front with an expansion of 20 basis points (bps) to 26.8 per cent, while the key highlight was the total contract value (TCV) of $9.2 billion, its highest ever.

However, analysts had mixed views as they believe that challenges remain in terms of valuation, which is expensive and has priced in the positives, though they feel TCS is well positioned to leverage expected industry growth.

“We expect TCS to be relatively better positioned (versus the sector) to leverage the acceleration in large deals as clients increase spends on Cloud.

Backed by strong deal wins in FY21 and continued momentum in Cloud and data, we expect the company to deliver 16 per cent dollar growth CAGR over FY21-23E,” said analysts at Motilal Oswal Financial Services.

The brokerage added that it remains positive on the company, but is ‘neutral’ given the elevated multiples. The stock currently trades ~25 times its FY23 estimated earnings per share (EPS). The brokerage has a target of ~3,250 on the stock.

Meanwhile, analysts at ICICI Securities downgraded the stock to ‘hold’ from ‘add’ with an unchanged target price of ~3,350, as they believe that industry growth is unlikely to witness a meaningful acceleration (versus pre-covid) over the medium term as expected by the Street.

Rebasing exchange rate estimates, ICICI Securities expects FY22E EPS to witness 5 per cent upgrade even as its FY23E EPS remains largely stable. However, it added that in the context of the second wave of Covid-19 in India, TCS should command relative investor interest, given the low to no disruption to the IT sector and perception of the stock as a cash proxy during heavy market volatility.

Global brokerage Citi also maintained a ‘sell’ rating though it raised the target to ~2,935 from ~2,870. “TCS continues to execute well, however, valuations at 31x one-year forward price in the positives. We raise EPS estimates by 2 per cent for FY22E/23E, partly on account of [dollar-rupee] adjustment. We continue to prefer Infosys over TCS,” it said.

On the flip side, Jefferies, CLSA, Credit Suisse, JP Morgan, Macquarie, and Edelweiss Financial remained bullish on the stock.

Countering the argument on valuation, Jefferies said: “While TCS trades at 50 per cent premium to its 10year average PE, with the spread between bond yield and its earnings yield near average levels, there is scope for further re-rating.” Jefferies raised TCS’ earnings estimates by 1-2 per cent to factor improved growth visibility, and better margin performance in Q4. It has increased the target to ~3,740 per share based on 32 per cent PE.

Edelweiss Financial, which has one of the most bullish targets on the stock of ~4,176, believes TCS’ strong numbers for the third consecutive quarter highlight the possibility of a multi-year technology upcycle.

Meanwhile, as TCS is the sector bellwether, the weak sentiment around its stock pulled down other IT stocks, which were down between 1 and 3.8 per cent, except for Coforge which fell 8 per cent. As a result, the benchmark IT indices were the top losers in Tuesday's trade on NSE and BSE. On Tuesday, broader markets saw a rebound after steep losses a day earlier.

Overall, analysts advise that corrections could be used to accumulate good IT names on dips.