TCS increases its digital agenda

Analyst Andrew Lange on India's largest IT services provider.
By Morningstar Analysts |  19-07-16 | 

TCS reported a solid start to the fiscal year with broad-based demand for both efficiency and digital led initiatives.

For the first quarter, the company recorded nine large deals across seven vertical markets. Most of the large deals included some flavor of digital (social, mobile, analytics, and cloud) work, and TCS indicated that digital revenue accounted for 15.9% of its total first-quarter revenue (up from 15.5% in the last quarter).

We believe good digital positioning will be important for IT service providers given the higher growth profile of the services relative to more traditional efficiency-type services.

We think TCS is heading in the right direction with a growing proportion of its services derived from digital initiatives. The firm’s massive digital reskilling of its employees also highlights the importance of this endeavor as the company has now trained over 165,000 of its employees in new digital technologies).

Our long-term outlook for the firm remains unchanged at this point. We reiterate our Rs 2,725 fair value estimate and narrow economic moat rating. We think investors should seek a more moderate margin of safety before investing in the firm.

For the quarter, revenue rose 14.2% year over year to Rs 293 billion (increased 10.1% in constant currency).

Management noted that it would have liked to see a stronger performance from the important banking, financial services, and insurance (BFSI) segment (about 40% of group revenue).

Macroeconomic conditions were attributed to the BFSI weakness. Brexit was an obvious point of discussion on the quarterly call. Management noted that it still remains a big unknown at this stage, although it is monitoring the situation very closely. We expect some short-term spending softness within BFSI given a heightened sense of uncertainty in the U.K. and the continent (TCS derives about 14% and 8% of its revenue from GBP and EUR, respectively).

Operating margins dipped 100 basis points sequentially to 25.1% after the firm raised employee compensation during the quarter. Overall, we expect operating margins to continue to hover in the 26%-28% range, in line with the company’s expectations.

  • Fair Value: Rs 2,725
  • Uncertainty: Medium
  • Economic Moat: Narrow
  • Moat Trend: Stable
  • Stewardship: Exemplary
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