TCS Q1 result is no balm for wary IT investors

Investors in Indian information technology (IT) stocks are nervous in large part because of fears that a potential economic downturn triggered by interest rate hikes could hamper IT companies’ deal pipeline Indian companies, thus affecting their revenue growth for FY24. Second, salary increases and the return of other costs are expected to occur in the June quarter 2022 (Q1FY23), eroding margins.

Here, the first quarter results of sector flagship Tata Consultancy Services Ltd (TCS) offer little comfort. In constant currency terms, revenue rose 3.5% sequentially, slightly less than consensus earnings estimate of 3.6%. However, management’s comments on the request continue to be strong. For now, the company sees no signs of slowing demand and the deal pipeline remains strong. That said, management is attentive to macroeconomic conditions and constantly interacts with customers. TCS management did not share any views on how FY24 should go, in terms of revenue or margin.

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Pain points

“Despite intact feedback, they indicated that the US would do better than Europe due to customer concerns over the slowdown. In our view, this is an early sign that industry feedback is becoming more realistic. compared to the current view of no impact on technology spending,” analysts at Motilal Oswal Financial Services Ltd said in a July 9 report.

Ebit (earnings before interest and tax) margin fell to a multi-year low of 23.1% from 25% in the prior quarter, missing the consensus estimate of 23.6%. Thus, TCS’ Ebit margin is below its aspirational range of 26-28%. Margin was impacted by wage increases, supply side challenges, higher outsourcing costs and increased travel costs. The margin should begin to recover sequentially from Q2FY23, management said.

Analysts are cautious. “TCS’s margin needs to recover quickly for the company to avoid further downward earnings revisions,” an analyst at an international brokerage said on condition of anonymity. It will take a few more quarters for attrition to start to drop significantly, contrary to what was initially expected. “Overall, a key takeaway for IT stock investors is that margin pressure is being underestimated by the street. After TCS’ first quarter results, we believe Infosys could also disappoint on the margins,” he said.

In the first quarter, TCS attrition based on LTMs (trailing twelve months) fell from 17.4% in Q4FY22 to 19.7%. Management expects the attrition rate to begin to moderate in the second half of FY23, but only after seeing a new spike in the second quarter of FY23.

Additionally, TCS net hired 14,136 employees in Q1FY23, which is low. That compares to the previous six-quarter average of about 23,000, analysts at Nirmal Bang Institutional Equities said. IT stock investors would do well to watch this metric. TCS has a more recent hiring target of 40,000 for FY23.

Another important metric, order backlog, was flat year-over-year (yoy) in 1QFY23 at $8.2 billion. Unless there is a good increase in order intake over the next few quarters, TCS’ total order intake for FY23 will be at best flat year-on-year and most likely lower, according to the Nirmal report. Bang.

Meanwhile, so far this calendar year, TCS stock is down 13%. Given the factors mentioned above, the stock is unlikely to see a quick recovery. TCS shares are trading at a 25x price-earnings multiple on FY24 earnings estimates, according to Bloomberg data. A few brokerages cut the company’s earnings estimates for fiscal 23 and 24 after the first quarter result. How valuations move from here will also depend on whether earnings downgrades worsen or not.

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