TCS Q1: Wage Hike Impacts Margins | NDTV Profit
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00:00Girish Pai, Head of Institutional Equity Research at BOP Caps joins in.
00:04Girish, good morning.
00:05Thank you very much for joining us this morning.
00:09What are you viewing this as, glass half full or glass half empty?
00:12Revenues beat expectations, all major markets have returned to sequential growth, operating
00:16margins have also done okay, this is sequentially a quarter when they undertake wage hikes and
00:22hence the impact on margins.
00:24All in all, has it met your expectations, the earnings, before we go into what you made
00:29of the commentary?
00:30Yeah, thanks for having me on your show.
00:33So I think on the headline side, I would say the numbers beat my expectations, I had a
00:38one and a half percent sequential CC growth expectation and a margin of 24%.
00:44I think the numbers beat on both fronts, 2.2% on the revenue growth side and 24.7% on the
00:51EBIT margin side.
00:52But I think if you dig a little deeper, the picture is a little different.
00:57And also the commentary wasn't really that positive.
01:01So on the commentary side, the company continued to say that the demand picture is very similar
01:06to what we've seen in the last many quarters now, there are client ramp downs happening,
01:13clients are re-evaluating their spend at very short notice.
01:17So that's a picture that we've kind of seen in the previous quarters too.
01:21The TCV number wasn't too great at 8.3 billion, that was down 37% quarter on quarter, some
01:2818% year on year, which is a dampener.
01:32And I would say even the growth number 2.2%, if you strip off the India quotient, which
01:38is largely the PSNL digit in my opinion, your international growth was 1%.
01:43Yes, it is a little better than what international growth was in the previous couple of quarters.
01:49I would still think that 1% isn't like too great a growth to talk about.
01:53So net-net, if you dig deeper, I would think that the quarters numbers weren't too great,
01:59the commentary isn't too great, but the company continued to say that FY25 is going to be
02:05better than FY24.
02:06The question is by how much?
02:08I feel like these earnings have met our expectations because we've revised our expectations in
02:15that sense.
02:17We've gone in with very low expectations in terms of what is the outlook.
02:21I know India has grown largely because of PSNL, but the other geographies and the US
02:26especially, most believe that a significant recovery can only come away post-elections
02:31in the US.
02:32How are you viewing this?
02:33Is it lower expectations and hence an upbeat or they've actually done okay?
02:40So I would say, if you look at the earnings cycle for the sector itself, I think probably
02:45this quarter we'll probably see a pause or maybe a little bit of an uptick, but I'm not
02:49sure whether I would want to call for a sustainable uptick from here on because I think the key
02:56number or key thing to watch out for is whether the consensus expectations of a high single
03:01digit or very low double digit kind of revenue growth pickup in FY26, and I'm talking of
03:06dollar revenue growth here for the tier one companies, whether that is going to come through.
03:10There is not much visibility on it.
03:12I think client behavior doesn't indicate that, I mean, of course, client behavior can
03:17change very quickly in a few quarters time, but if you look at how things are panning
03:23out from the macro side, while on the one hand there is talk of a soft landing, there
03:27is also concern on certain data points coming out of the US, which indicates that it may
03:32not be a soft landing situation going into the second half of 2024 or in 2025, and the
03:42political side, the political economy, so to speak, in the US, if Trump does come to
03:47power, what impact would tariffs that he says he's going to levy on Chinese imports and
03:53imports from other countries, how much of an impact it's going to have on inflation.
03:56So there are various angles to the story on the macro side in the US, which will probably
04:01become clearer maybe towards the second half of 2025 or in the middle of 2025.
04:07I think clients will still be grappling with uncertainty in the first half of the calendar
04:13year of 2025.
04:14So my sense is that the pickup may be delayed a bit, but so we will have to wait and see
04:20whether the FY26, you know, high single digit to low teen kind of a growth for Tier 1 companies
04:27is actually going to come through.
04:28So that's the debate in the market right now.
04:32Girish, good morning.
04:33Tamanna here, just wanted to get your view on a couple of things that the real growth
04:39significantly for TCS is coming from the India business and largely from BSNL.
04:46The BFSI growth has come into positive territory after five quarters, agreed.
04:52But this sort of concentration on India and BSNL as the core driver, does that concern
05:00you or do you see that then panning out over time?
05:03No, if you, you know, do nitpicking, yes, I would say, and if you look at the larger
05:10international book, which is probably if you go by the latest quarter numbers, that's about
05:1492 and a half percent of the business that's, it's just picked up in growth.
05:19It was probably not growing or probably declining in the quarters, a couple of quarters before
05:24that.
05:25To that extent, it is a positive.
05:27But having said that, I think the growth this year in FY25 and maybe to the second
05:32half of last year was largely, in my opinion, driven by BSNL and BSNL order, in my opinion,
05:38is probably a lower margin business.
05:42The company doesn't talk in terms of client specific margins, but I think that has been
05:47offset.
05:48So the margin surprise, so to speak, compared to what my expectations were, have largely
05:54come from better productivity and better, you know, utilization.
05:59And more importantly, the subcontracts have gone up or gone down dramatically for the
06:03company over the last three, four, three, three quarters now.
06:07And that has been one of the key drivers of the margin surprise, so to speak.
06:13So I think FY25, the growth element is going to be driven to a decent extent by BSNL, which
06:20does then put a question mark around the FY26 numbers, because then you have to kind
06:25of overcome that number that sits in the base.
06:29So yeah, that is a bit of a worry.
06:32But again, if you look at TCS, TCS has been saying that it wants to diversify its revenue
06:36base beyond the US and Europe and look at other geographies.
06:40So I would say if you look from a long term perspective, yes, the geographic diversification
06:45towards India and some of the other non-developed markets is a good thing.
06:49But near term, I would think that there is going to be a little bit of worry there.
06:53Gireesh, good morning, Neeraj here.
06:58So what does this therefore do?
07:00Does it give you, assuming that INFI sounds similar, assumption of course, would it give
07:07you ammo enough to be constructive large cap IT?
07:11Or would you prefer, as some people have been talking about, and we haven't spoken for a
07:16while, so I don't quite know your view there.
07:18But as some people have been talking about, whether the mid cap IT would be more nimble
07:22on generative AI deals and AI led numbers as well, and versus the valuations that each
07:27of those trade at?
07:29Neeraj, so I think if you look at tier 1 and tier 2 valuations, I think both are at a premium
07:37to what they've been trading at over the last five years or even 10 years.
07:42Vis-a-vis 10 years, they are significantly higher premium that both tier 1 and tier 2
07:46collectively are trading at, more so tier 2.
07:50So I would say that ConsenSys is already building in a fairly strong growth in FY26 and the
07:55valuations, if you look at on the basis of FY26, I would think that growth is already
08:01factored in and probably it's at a premium right now, unless there is a big surprise
08:06there, which I think is highly unlikely, the way I see it.
08:11And in tier 2, so tier 1, I think the challenge is the growth part.
08:17So you saw a couple of years of very strong growth driven by what people call compressed
08:22transformation.
08:24We talk of second half of 2022, maybe the full calendar year of 2022.
08:28We saw extremely strong growth for the sector, which is probably like 3x the normal trend
08:35growth of the sector, so to speak.
08:37And I'm talking Indian IT services sector, which I think is probably normalizing.
08:42And once we get through probably the FY26 spike, which is probably pent up demand driven,
08:50you will probably see growth back to that 6-7% kind of level for the tier 1 companies.
08:56Tier 2 companies will definitely grow faster because of the lower base.
08:59But I think from a multiple standpoint, they are at a significant premium to the tier 1
09:05companies.
09:06I don't think the earnings growth gap that existed between tier 2 and tier 1, which has
09:13been the case, which is pretty significant in the last 2-3 years, is going to sustain
09:17going forward.
09:19I guess just a last point on the AI sort of numbers that DCS has put out and 270 deals
09:27ramp up on AI, of course, but no clarity on when this is going to start becoming revenue
09:33accretive or really make a huge difference.
09:36What is your take on sort of where they are on the AI roadmap?
09:41Yeah, so this whole generative AI thing is a bit tricky because just like in digital,
09:46when it happened like 5-10 years back, the definition itself kind of will be different
09:52across various companies.
09:54So what falls into digital and what falls into generative AI could be different across
09:58companies.
09:58So it may not be an Apple to Apple comparison.
10:01But I was expecting, because it's the start of the year, that DCS and some of the Indian
10:07companies would start giving some metrics around generative AI.
10:11DCS disappointingly gave only the pipeline, which has actually improved from 900 million
10:16that existed a quarter back to now 1.5 billion.
10:21That's just the pipeline.
10:22It doesn't say much on the order and flow side of the revenue side, whereas you had
10:25Accenture come out and say that the order and flow number for the nine months of this
10:32year, their year ends in August, was about 2 billion dollars and the revenue was about
10:38500 million dollars.
10:39So I would say that probably Accenture is the only one that's kind of put out this data
10:44point.
10:45So on generative AI, I'm a little...
10:47So it's taken a while.
10:48I think it'll take a while for it to kind of blossom and become a bigger part of the
10:53revenues.
10:54I think the challenge here is that my sense is the surround services spend that needs
10:59to be done to implement a generative AI project is a pretty significant number.
11:04And in one of the analyst calls, one of the CEOs of a tier one company said that it is
11:0825 is to one.
11:10So you need to spend 25 dollars to on the surround services side, which is about going
11:15to the cloud, doing data modernization, cyber security and all that to actually spend one
11:21dollar on generative AI.
11:23That is a significant spend.
11:24And you need a clear return on investment metrics to actually get those companies, customers
11:31to invest in such projects.
11:32So I would think it'll take a while for this to pick up.
11:36At least that's my expectation right now.
11:37I don't know whether things will speed up in the in the upcoming quarters.
11:44Thanks Girish for that.
11:45That's the word coming in.
11:47Girish largely thinks the earnings by TCS are in line with what the street was expecting.
11:52So no major disappointment on that front.