Strong revenue growth to help TCS overcome margin issues

While all attention was focussed on the change of guard and the Annual General Meeting at Infosys, sector leader TCS held an analyst meet late last week which helped restore faith in the company and the sector. IT counters had seen profit booking as investors shifted money to other sectors of the economy in anticipation of a strong and early recovery post a new government. A strengthening currency also provided additional reasons to move away from the sector.

 

Strongly recommending a buy on IT companies, Sandip Agarwal and Omkar Hadkar of Edelweiss Securities say that there is a limited impact of rupee appreciation on the sector which can be offset by robust domestic demand and a few concrete initiatives by the new government. Further, they say that huge cash balance in these companies can be returned to shareholders, either through dividend or buy back, thereby improving their return on equity (RoE).

 

TCS has strengthened the confidence of the analysts in the company by reiterating that the current fiscal will be better than the previous one. Following are the key takeaways from the company’s analyst meet.

 

Growth rate intact

Not only did the company say that its annual growth rate will be better, TCS said that the first half of the current fiscal will be better than the second half of the previous year. Europe will continue to drive growth for the company. Growth is expected to be driven by increasing adoption of outsourcing (non-discretionary/annuity projects) in Europe. Revenue growth from the US would be close to company average and will be led by project based discretionary demand and digital technologies. Contribution from India is expected to be flat.

 

In terms of vertical, smaller ones like Media, Life Sciences and Travel/Hospitality would grow faster than the company average. Larger ones like BFSI (Banking, Financial Services and Insurance), manufacturing and retail would grow close to company average.

 

Margin pressures

While there are no negative surprises on the revenue front, TCS is expected to take a hit on account of wage hikes that were implemented during the quarter. The company will also take a hit of around 100 basis points at the earnings before interest and tax (EBIT) due to currency appreciation. Further, TCS may take a hit on account of business investments, visa costs and non-recurring impact of change in depreciation policy. A one-time impact due to change in depreciation policy as per International Financial Reporting Standards (IFRS) will result in an additional charge of 2 per cent on fixed asset and a write-back of 4-5 per cent as per Indian GAAP.

 

Analysts upbeat

Reiteration of strong headwinds on demand front from the Europe and USA has led Edelweiss to maintain its ‘Buy’ rating on the company with a price target of Rs 2,538. IDFC Securities has reiterated an ‘Outperfomer’ rating on the company with a price target of Rs 2,700 for the year. IDFC argues that the company is on track to register industry-leading USD revenue growth with market share gains in Europe and a strong presence in non-English speaking markets that should keep the growth engine rolling.