Investing in TCS? Street may be ignoring these three near-term headwinds | Business Standard News

1. Investing in TCS? Street may be ignoring these three near-term headwinds The market capitalisation of Tata Consultancy Services (TCS) is close to the Rs 6- trillion mark, with the company’s stock gaining 46 per cent over its 52-week low of February last year. Half of the gains have come over the past month, and a large part of those after the December quarter results. Given the sharp price rise, the stock is trading at an expensive valuation of 20 times its FY20 estimates. The near-peak valuations are at a 10-14 per cent premium to the target prices of brokerages. Analysts at Kotak Institutional Equities say that the stock is trading at full valuations even after the recognition of potential cyclical uptick in business. The stock has already reached the peak-cycle multiple, implying about 12 per cent growth for the next 7-8 years.

2. While the Street’s enthusiasm after the results rests on a positive commentary on the outlook both from TCS and other peers, a positive trend in deal signings and strong traction in the high-growth digital segment, there are three risks to these valuations. The first is the weakness in the banking financial services and insurance (BFSI). In addition to the retail vertical, BFSI has been the other key laggard for the Indian IT services in recent quarters. While the retail business for TCS looks like it is coming out of the woods, given the six per cent sequential uptick in the quarter, BFSI, the largest vertical accounting for over a third of overall revenues, continues to be a problem. The vertical registered a revenue decline of 1.7 per cent. Analysts at HSBC say that given the company was non-committal on the outlook for the BFSI space, this would mean that growth for TCS will remain restricted to the 6-8 per cent range until banking, which is a third of the business, picks up in earnest. While some of the BFSI companies have not finalised on their budgets and are holding back, what is a key negative is the trend of in-house implementation of IT projects. This captive shift has led to the shrinking of budgets for existing projects and could impact future projects as well. The other negative is the additional tax burden under the new US tax regime. Analysts believe that there could be a 100-basis-point increase in tax rates resulting from the implementation of Base Erosion and Anti-abuse Tax (BEAT) in the US. Finally, what complicates the matter is the hardening of the rupee which will impact revenues. Some analysts are factoring in Rs 64 a dollar in their estimates, compared with Rs 65 earlier. Analysts at Credit Suisse believe that though TCS margins have been stable, its FY18 margins are likely to fall short of its targeted range of 26-28 per cent, with adverse currency movement being one of the reasons. While strong growth in all verticals barring BFSI is a positive and the 14 per cent sequential revenue growth in digital services (22 per cent of revenues) should help revenues, given the near-term headwinds, investors should be cautious rather than run with the current momentum.

3. Article By - Business Standard