TCS Q1 review: Brokerages caution against early signs of demand slowdown

The company has indicated that the near-term demand outlook remains strong, but senior-level client executives have started discussing a potential recession, said Nomura.

Shares of Tata Consultancy Services (TCS) dropped over 4 per cent to Rs 3,111 apiece on the BSE on Monday as investors exited the counter after the company reported a soft June quarter (Q1FY23).

While TCS beat Street estimates on the revenue front, reporting a 16.2 per cent increase on a yearly basis to Rs 52,758 crores, the net profit rose by 5.2 per cent to Rs 9,850 crore, which came below expectations.

The margins for the quarter also touched a multi-year low of 23.1 per cent -- lowest since Q1FY09 -- falling 2.4 per cent year-on-year (YoY) due to wage hikes, and an increase in travel costs. 

Brokerages have maintained a mixed consensus on the company; here’s a rundown of their takes:

Nomura: According to the brokerage, TCS' guided deal booking for the near term is $7- 9 billion per quarter, which indicates a flattish YoY number. Although the management has indicated that the near-term demand outlook remains strong, in some client conversations, senior-level executives have started discussing a potential recession and the management is, hence, vigilant.

"We lower FY23-24 forward EPS by 1.4-2.5 per cent considering lower revenue and margin assumptions", it said. The brokerage has cut target price to Rs 2,910, and has maintained 'Reduce' rating.

Ambit Capital: The brokerage said that signs of weakening in demand have been reflected by the company's caution on Europe business amid fears of a potential macro slowdown. Likely growth and margin moderation suggests TCS is not immune to sector risks, and the current valuation (at 36 per cent premium to pre-Covid average) is not justified, the brokerage said. It has trimmed EPS estimates by 2-3 per cent, and has cut the target price to Rs 2,865

The company's UK and continental Europe segment revenues came 3.3 per cent and 0.7 per cent lower, respectively. 

Kotak Institutional Equities:  The brokerage believes EBIT margins have bottomed out and will likely improve from here as benefits of leverage from growth, pyramid, higher utilization and lower subcontracting costs flow through. However, it has cut the FY23 Ebit margin estimate by 80 bps, keeping FY24 estimates largely unchanged.

Motilal Oswal: Despite intact commentary, the company indicated that the US business will do better than Europe due to client concerns over the slowdown. This, the brokerage believes, is an initial sign of industry commentary turning more realistic vs the current view of no impact on tech. It has maintained its 'Buy' rating but expects Ebit margin in FY23 to decline 110 bps YoY to 24.2 per cent.

The brokerage has also lowered its FY23/FY24 EPS by 4 per cent to account for lower margins. 

IDBI Capital: While the brokerage expects TCS' revenue growth to remain robust in the near-term, as the impact of macro concerns will be felt with a lag of two quarters, it remains cautious on the medium-term revenue growth outlook on high inflation and recession fear. It expects the company's dollar revenues to rise at a lower CAGR of 9 per cent over FY22-FY24E.

It has maintained its 'Hold' rating with a revised target price of Rs 3,110.

Dolat Capital: It expects TCS to operate at 23.6 per cent margins for FY23 as against management’s estimate of over 25 per cent.This, the brokerage said, necessitates a more robust growth rate that appears difficult at present. It has maintained a 'Reduce' rating on the stock with a target price of Rs 3,330.