Why are TCS Q3 results not exciting enough?

Revenue growth has been better, but profit margin has been lower than expected. Furthermore, the management’s commentary does not provide any clarity on what lies ahead for TCS in terms of revenue growth or deal pipeline.

Sequentially, constant currency (CC) revenue growth stood at 2.2%, which was ahead of consensus estimates. It also indicates that the holiday situation is not as bad as was predicted earlier. However, the growth was also partly driven by regional markets, where demand fluctuates and hence, its stability is difficult to predict.

In the earnings call, the TCS management indicated that while the manufacturing vertical has shown good performance, it is wary of this segment due to global supply chain and energy disruptions. Management pointed to growing caution among customers, particularly in Europe.

In Q3, TCS saw a sequential decline in total contract value (TCV) of deals to $7.8 billion. As a result, the book-to-bill ratio fell. While the order book was in the guidance range of $7-9 billion, the sequential decline reflects slower deal conversion due to increasing uncertainty among customers.

“Decreasing headcount and book-to-bill ratio falling to a three-year low is a sharp growth moderation,” said analysts at Jefferies India. CC revenue is much slower than the 14% year-on-year CC revenue growth expected in FY23.

TCS expects the exact customer spending trends to emerge only in the next few months. In addition, hiring was down sequentially in the third quarter, after several quarters of growth. “The new addition of 7,000 means that TCS is not filling back some lateral positions. Fresher additions will be more moderate in Q4FY23, while we expect caution on lateral hiring, which could lead to another quarterly decline in net headcount, said analysts at Kotak Institutional Equities.

The TCS management said it is trying to utilize the excess capacity and improve employee productivity following fresh hiring in recent quarters. But according to some analysts, the moderation in hiring could be another sign of caution. What’s more, TCS’s performance has not been encouraging as compared to its close peers. “TCS’s growth over the past 12-13 quarters has been lower than Accenture (outsourcing) and Infosys Ltd,” said analysts at Ambit Capital. The risk of escalation remains.

Clearly, in this backdrop, the expensive valuation of TCS stock is an added disappointment. According to an Ambit report dated January 10, TCS’ FY24 price-to-earnings multiple of 26.8x is a 30% premium to its pre-Covid three-year average. Additionally, the recent slowdown fears among IT investors have hurt the sector’s FY24 revenue growth and deal momentum. These factors should restrict any meaningful upside in TCS stock in the near term.

Meanwhile, easing supply-side pressure and increase in vendor consolidation augurs well and is assisting the company’s market share gains. In Q3, TCS’ operating margin improved by 50 basis points sequentially to 24.5%, aided by foreign exchange gains, better utilization and moderation in subcontracting expenses. Even though costs like travel are coming back, TCS is confident of exiting FY23 with a margin of 25%.