TCS slips 6% on BFSI outlook recast. Should you sell?

Information technology (IT) stocks took a hit in trade on Thursday, after TCS warned of a slowdown in discretionary spending in the BFSI (banking and financial services) vertical. The stock lost 6% in morning trade to hit a low of Rs 2,284 levels on the National Stock Exchange (NSE). The vertical contributed nearly 40% to the company’s revenues in the first quarter ended June 2016, reports suggest.

HCL Technologies, Tech Mahindra and Infosys were among the other losers that lost 2.2 – 2.6%. Wipro, at Rs 470.2 hit its 52-week low on the NSE in intra-day deals. A fall in these heavyweights dragged the Nifty IT index nearly 3% lower in intra-day deals on Thursday.

 
"TCS, raising a red flag, has disclosed lack of momentum in US BFSI spends and some early signs of weakness. On the positive side, though, Europe BFSI is doing well despite Brexit and management has maintained its commentary on rest of business/services verticals. The US caution clearly reiterates our thesis that TCS, with huge dependence on H1, has very little margin of safety," say analysts tracking the company at Edelweiss Research.

Since the presentation of the Union Budget in February 2016 when the sentiment turned positive for the overall markets, IT stocks have remained underperformers. The Nifty IT index has been mostly flat – up a modest 0.3% till close of trade on September 07, as compared to 27% rise in the Nifty50. 

Earlier, Infosys had lowered its annual revenue guidance for FY17 while announcing its results for the June 2016 quarter to 10.5 – 12% in constant currency (CC) terms, as against a market expectation of 11.5 – 13.5%. 

Given the growth concerns, analysts say that the sector seems to be facing more headwinds than tailwinds, with a high probability of those headwinds materialising.

“We see an imminent cut to the consensus estimates over the next few months, with a commensurate valuation de-rating. We maintain our underweight call on the IT Services sector – on the back of their inefficient capital allocation policy of the last decade and increasing uncertainty in the business environment across the world,” said Vibhor Singhal and Shyamal Dhruve of Phillip Capital in their August 30 report.

As regards TCS, analysts at IIFL have lowered their earnings before interest and taxes (EBIT) expectation.

“The weaker revenue growth also implies more margin headwinds. TCS’ FY17 EBIT margins are likely to be below its target range of 26-28%. YTD, we cut EPS estimates for peers by 8-14%. We are now cutting our earnings per share (EPS) estimates for TCS for FY17/18 by 2-4%. Our new target price of Rs 2,440 is based on 16x (2.0 PEG) two-year forward price-earnings ratio (PER),” they say.

 

Since Q2 is a seasonally strong quarter for the IT sector, analysts tracking the company at Sharekhan suggest that it will be difficult for TCS to grow beyond 8-9% in FY17. 

“The company also sees sequential loss momentum in the BFSI vertical in Q2FY17. As we have maintained, IT sector is going through a transition phase, with industry specific issues and pricing pressure, it is pertinent to expect volatility in earning performance, we maintained our cautious stance on the sector,” they caution.

Given the weak management commentary, analysts at Religare Institutional Research expect Q2 revenue growth to be 1-2% quarter-on-quarter (q-o-q) from 3.1% (constant currency) in Q1. Additionally, since H2 is seasonally weaker, they now expect growth for FY17 to be in single digits. 

"Current consensus estimates build in a 2.6% CQGR for FY17, which we don’t think will be delivered given the Q2 warning. Our estimates have been around 3% below consensus and we expect cuts (3-4%) to consensus estimates on account of this warning," point out Rumit Dugar and Saumya Shrivastava of Religare Institutional Research in a report.

"We have maintained that the growth differential between larger peers has narrowed down and TCS’s earnings expectations remain high. Hence, we think valuations at 17x F18E PE are not justified. We also expect valuations for TCS to converge with other large players (particularly INFO) given the high BFSI concentration risk and potential earnings downgrades for TCS. Reiterate SELL," they add.