TCS scrip: Analysts positive despite revenue miss

Management confidence on achieving strong growth in FY16 a key reason for bullishness

Following a little weaker than expected revenue growth in the March quarter, Tata Consultancy Services’ stock fell 4.2 per cent in Friday’s trading to Rs 2,476.2, as against a 0.8 per cent decline in the benchmark S&P BSE Sensex.

However, barring Infosys (down 0.7 per cent), other large information technology (IT) companies’ stocks also fell between 1.5 and 2.5 per cent on Friday.

Despite the results, a majority of analysts remain bullish on the company. Of the 33 polled by Bloomberg Thursday and Friday, only four have a ‘sell’ rating, while 15 have a ‘buy’ and the remaining 14 a ‘neutral’ one on the stock. Their average target price is Rs 2,749, an upside of about 11 per cent from Friday’s closing price.

Strong management commentary around the deal pipeline, client budgets and overall growth is a key reason for this optimism. TCS’ good implementation record, leadership position and ongoing investments in new technologies (digital) and regions are others.

“TCS will grow in line or faster than the industry in FY16 but not have the same lead as in the past three years. TCS’ leadership across multiple dimensions, though, would sustain premium valuations,” write analysts at Kotak Institutional Equities in a post-results report.

However, some analysts did trim their FY16 revenue and earnings estimates but by only two to four per cent to factor in the weak March quarter. TCS’ performance in the first half of this financial year will be key in determining the full-year growth.

“While this (March) quarter will be counted as a disappointing one, the stock has under-performed and underlying fundamentals seem solid. However, solid growth in the first quarter of FY16 will be required as a positive strong catalyst for the stock. We have slightly lowered our EPS (earnings per share) estimates to account for currency headwinds,” said Anantha Narayan of Credit Suisse.

The TCS management remains confident of achieving healthy growth in FY16, despite weakness continuing in the three troubled segments of telecom, energy and Diligenta (insurance), which together form 14-15 per cent of consolidated revenue. Overall, the management aspires to beat the Nasscom revenue growth forecast of 12-14 per cent for the sector in FY16.

On margins, given the peak utilisation and limited scope for realisation gains (marginal in the past few quarters), it seems the margin levers might not be significant. Rising attrition is another sore point, albeit a function of a buoyant job market, and is a problem for most IT companies. The management plans to reinvest significant margin gains back into the business and plans to maintain the Ebit (earnings before interest and taxes) margin at 26-28 per cent.

While any improvement in the troubled segments will lead to positive surprise on the upside, a weakening of overall demand will be a key downside risk.

Meanwhile, analysts believe the stock’s recent weakness offers an attractive entry point. Viju K George of JPMorgan writes, “We advise investors to enter TCS on declines. TCS continues to stay confident of the demand environment shaping up as it enters FY16. So, unless things get better from here, it is hard to see how TCS can reasonably outperform FY15 on growth in FY16, on organic constant currency growth.” George has a neutral rating on the stock, with a target price of Rs 2,700.