Meeting margin target could prove tough for TCS

Rising pricing pressure, slowing revenue growth, possibility of higher visa costs could weigh

In its post-results conference, Tata Consultancy Services (TCS) repeated it would be able to achieve operating profit margin of 26 to 28 per cent. While most view this as a positive, some are not convinced. 

"We continue to believe that limited margin levers constrain TCS's earnings growth. Moreover, the company's excellent execution and key metrics leave limited margin levers, implying limited earnings growth," says Sandip Agarwal, analyst at Edelweiss Securities. 

In fact, TCS's margin has remained between 25 and 26 per cent over the past four quarters and has not touched 28 per cent since March 2014. This figure, 29.1 per cent then, has been range-bound since. Rising pressure on pricing across the industry, continued investments in digital business, and weakening revenue growth have kept margins in check.

With rising protectionism on H1B visas in the US, there is a fear that costs associated with these visas and/or expenses related to hiring US locals could go up. If that happens, it will be another overhang on the margins of TCS and peers, believe analysts. TCS, on its part, has stepped up recruitment in the US and has applied for only 4,000 visas in 2016, which is a third of that applied in 2015. 

Against this backdrop, most analysts peg FY18 margin at the bottom of the range forecast by TCS, with some also putting the figure below 26 per cent. TCS needs to raise revenue growth in order to drive margin. "Upside potential from automation, higher offshoring, and a flattening of its employee pyramid exists, but everything hinges on revenue growth," says Neerav Dalal of Maybank Kim Eng. TCS's focus on driving operational efficiencies can offset some pricing pressures but may not be enough to fuel margin expansion, believe analysts. After change of guard at the top, investors are watching for attrition, often witnessed during management rejigs. 

Overall, TCS stock is likely to remain under pressure. It will be interesting to see if its premium valuation versus Infosys sustains.