Q1 disappointing; TCS unlikely to outperform in near future: Mahantesh Sabarad

What is the sense that you get looking at numbers?
Clearly there seems to be a little disappointment in the numbers relative to the expectation that was being built up. The big ticket number that I was looking for was the deal wins which came at about $8.2 billion. Remember, in Q4, it was $11.7 billion. Two big billion dollar plus deals were struck in Q4. Excluding that, it was still around $9.5 billion in Q4.

Compared to that, the deal wins of $8.2 billion are substantially lower and so that is one big disappointment that I am looking at because finally the future growth trajectory will be determined by the deal wins. The margin disappointment also seems to be there, but though it appears a little marginal it was expected that the margins are going to soften because of the heavy rupee depreciation that we were seeing and the high attrition numbers that were expected. So margin disappointment is there but it is a tad lower.

Finally the PAT number and the bottom line seems to be much lower than what was expected by the Street and that will drive the lowering of estimates. All in all, it appears that instead of an upgrade in numbers, we are looking at a downgrade in numbers by analysts going forward. How much of that is in the stock price remains to be seen.

The stock has fallen substantially from Rs 4,200 to Rs 3,200. In terms of any downgrade, what would you say? Have the markets already priced in that? It will be difficult for them or rather the entire IT sector to beat numbers?
You have to look at it from a valuation perspective as well. While the stock price has come down and the valuation has moderated, relative to its past averages, it is still quite high in terms of PE multiples on a forward earnings basis.

Therefore, I would reckon that with earnings disappointment right now and likely downgrades, the valuations appear more expensive and it will be a case for valuations to moderate further. I do not think TCS is likely to outperform in the near future. The downgrade is something that we need to look at unless the management tells us some other things in terms of how well they would be doing on some of the new initiatives that they have been taking.

I would keep my fingers crossed and I would say that this is not a good result.

How have you read into the management commentary? Some of the forward looking statements going forward acknowledging a lot of the challenges that persist within the IT space?
I think the management has given a hint that the quarter was indeed challenging and therein also lies a little bit of hint that since the macros are destabilising across the world, it may be a tad more difficult for TCS to keep up the momentum that they have been achieving thus far.

So crucially, I would look at the next quarter’s deal wins once again and look at whether the next quarter margins show an uptick on a sequential basis to say that TCS is able to meet the challenges quite well from an operational point of view, but thus far, the Q1 and the commentary from the management hints at a little disappointment.

The number for the deal this quarter is $8 billion, which is definitely lower in terms of the run rate that we have seen recently. Would you call this a one off or given that there were a couple of big deal wins that the company had announced this quarter, this is coming as a bit of a surprise? What is your takeaway regarding that?
So let us go back two years ago when they showed a very strong momentum in terms of deals wins if you remember for FY21 year they close with the deal win growth of close to 17% year on year and thereafter they added the following year another growth at about 10%. There was a moderation of growth rate but the deal win was nevertheless quite strong.

On the back of it, if we have to project and say that FY23 at this run rate of 8.2 billion that they have achieved, and if they need to do double digit growth in deal wins, they need to hit a number closer to $36-37 billion for the year. Therefore it tells me that the balance three quarters’ run rate needs to be quite higher than what they have achieved and substantially higher than what they have achieved in the first quarter.

So the upcoming run rate for deal wins is going to be quite tough for them to achieve any decent growth on the deal win side and while margins are also a bit disappointment, the overall growth at the PAT level therefore may be subdued.

Management is sounding bullish in terms of order booking. But the management always gives a positive picture. What do you think markets would read into in terms of EBIT margins being lower considering that rupee has now fallen and the impact will come in the next few quarters?
On the rupee front, IT companies do hedging of their revenues. Forward revenues are always hedged and so they are not able to get the full benefit of the rupee depreciation that we see in a timely fashion or rather there is a delay in capturing any depreciation benefits particularly on the cost side to help them shore up the margins.

Having said that, we should also remember that TCS had reported very high attrition rates this quarter and that itself tells us that the challenge remains when as far as margin stability is concerned going forward. So despite the rupee depreciation turning out favourably, subsequently the challenge related to cost on the employee side may not get mitigated in the fashion that one would have hoped for.

I only hope that the deal wins growth rate going forward or the deal wins run rate hits closer to $10 billion and only then will we see upgrades come in on the TCS side. Otherwise there seems to be only disappointment as far as the current quarter is concerned.

What kind of EPS cuts are you pencilling in? Is it going to be a 2% to 5% cut or is it going to be a bigger cut of 5% to 10%?
So as far as the commentary on the cost side is concerned, it is indeed heartening to see that the management seems resolute in terms of controlling the cost and therefore are looking at shoring up the margins ahead. As far as the earnings estimate cut is concerned, we would probably see a lowest cut in terms of earnings estimates probably somewhere around 2 to 3% or thereabouts not really in the 5% plus kind of range because most of the time, TCS has a habit of outperforming expectations in the past.

There are only a few quarters that we have seen that TCS disappoint the market. Having said that, the earnings estimate cut probably would remain muted. It has been in the 2-3% range and there is a possibility that as we come into the September quarter and then move into the December quarter, thereafter the deal wins are sufficiently large and the EPS cuts may just get restored.