Tata Consultancy Services (TCS)

CMP: | 2737 Target: | 3300 (21%) Target Period: 12 months BUY

October 8, 2020 Healthy operating performance, long term trend

positive

Tata Consultancy Services (TCS) reported healthy Q2FY21 results that were Particulars

above our estimates. The company reported 4.8% QoQ growth in dollar P articular Am ount revenues (in constant currency terms), above our estimate of 2.6% QoQ Market Capitaliz ation (| Crore) 10,26,375.0

growth. The growth was broad based across geographies and verticals. Total Debt (| Crore) 8,174.0 Margins increased 260 bps mainly due to an improvement in gross margins Cash and equivalents (| Crore) 35,939.0 and lower SG&A expenses. The TCS board has approved a buyback of E V (| Crore) 9,98,610.0 52 week H/L 2761 / 1504

October 15, 2020 while payment date is November 3, 2020). Key Highlights IT sector at cusp of multi-year technology transformation cycle  Technology is on the cusp of multi- TCS believes it is in the first phase of a multi-year technology transformation year growth and TCS is expected to phase. In the current phase, enterprises are building a cloud-based be a key beneficiary of the same. This foundation that will serve as a resilient, secure and scalable digital core. In will lead to double digit growth in subsequent phases, enterprises will see new age technologies developed revenues over a sustainable period around cloud to lead to new business models and differentiated customer experiences. TCS’ investments in building deep expertise on these  Cost rationalisation, improving platforms, in research & innovation and in industry-specific solutions will growth in high margin digital

make it a key beneficiary of this secular demand growth in coming years. technologies, benefits of lower Going forward, global digital technologies are expected to witness robust attrition and operating leverage growth (CAGR of ~20% CAGR in the next five years) while TCS is expected benefit to drive margins in long run to be a key beneficiary of this trend. Hence, although we expect the  Upgrade to BUY from Hold company to report a marginal decline in FY21E revenues, we expect TCS to recommendation with revised target witness double digit revenue growth over a longer horizon. price of | 3300 Cost efficiency to drive margins Research Analyst  Devang Bhatt The company has seen healthy margin growth in Q2FY21 led by improving [email protected] revenue growth and cost rationalisation. Going forward, we expect TCS to

Retail Equity Research Equity Retail witness a healthy margin trajectory led by cost rationalisation, improving growth in high margin digital technologies, benefits of lower attrition and – operating leverage benefit. Hence, we expect the company to witness 80 bps YoY increase in EBIT margins in FY21E followed by another 80 bps YoY and 30 bps YoY increase in FY22E and FY23E, respectively.

Valuation & Outlook

Going forward, global digital technologies are expected to witness robust Securities ICICI growth (~20% CAGR in next five years) led by robust growth in cloud, customer experience and robust growth in cloud native technologies. TCS is expected to be a key beneficiary of this trend leading to double-digit revenue growth over a sustainable period. This, coupled with industry leading growth & solutions, better capital allocation, stable management and higher revenue growth trajectory than witnessed in the past warrant a multiple re-rating for the company. Hence, we now assign 28x P/E to the company’s FY23E EPS. Based on this, we arrive at a target price of | 3300/share and upgrade the stock from HOLD to BUY. Key Financial Summary

F inancials F Y19 F Y20 F Y21E F Y22E F Y23E CAGR (FY20-23E) Net S ales 1,46,463 1,56,949 1,61,911 1,78,204 2,01,263 8.6% E B ITDA 39,506 42,110 45,011 50,966 58,165 11.4% E B ITDA Margins (% ) 27.0 26.8 27.8 28.6 28.9 Net P rofit 31,472 32,340 32,245 38,368 43,604 10.5% E P S (|) 83.8 86.2 87.2 103.8 118.0 P/E 32.5 31.7 31.3 26.3 23.2 R oNW (% ) 34.4 37.5 37.1 42.3 45.6 R oC E (% ) 43.8 43.5 44.5 49.0 52.9

s Source: Company, ICICI Direct Research Result Update | Tata Consultancy Services ICICI Direct Research

Exhibit 1: Variance Analysis Q2FY21 Q2FY21E Q2FY20 YoY (%) Q1FY21 QoQ (%) Comments Revenues in dollar terms increased 7.2% QoQ mainly due to Revenue 40,135 39,069 38,977 3.0 38,322 4.7 healthy growth in BFSI & retail and cross currency tailwind Employee expenses 22,958 22,504 22,410 2.4 22,486 2.1

Gross Margin 17,177 16,565 16,567 3.7 15,836 8.5 Gross margin (%) 42.8 42.4 42.5 29 bps 41.3 147 bps SG&A expenses 5,664 5,860 6,341 -10.7 5,811 -2.5

EBITDA 11,513 10,705 10,226 12.6 10,025 14.8 EBITDA Margin (%) 28.7 27.4 26.2 245 bps 26.2 253 bps Depreciation 998 977 864 15.5 977 2.1 EBIT 10,515 9,728 9,362 12.3 9,048 16.2 EBIT Margin (%) 26.2 24.9 24.0 218 bps 23.6 259 bps Higher utilisation and cost rationalisation drive EBITDA margins Other income (less interest) 740 442 1,168 -36.6 456 62.3 PBT 11,255 10,170 10,530 6.9 9,504 18.4 Tax paid 2,533 2,542 2,471 2.5 2,455 3.2 Reported PAT 7,475 7,586 8,043 -7.1 7,008 6.7 Reported PAT has a one-time exceptional item of | 1218 crore Adjusted PAT above our estimates due to higher-than-expected Adjusted PAT 8,693 7,586 8,043 8.1 7,008 24.0 operating margins and other income

Source: Company, ICICI Direct Research

Exhibit 2: Change in estimates FY21E FY22E FY23E Comments (| Crore) Old New % Change Old New % Change Introduced We expect FY22E and FY23E to witness robust Revenue 156,265 161,911 3.6 170,141 178,204 4.7 201,263 growth led by healthy traction in digital technology

EBIT 38,441 41,125 7.0 42,705 46,689 9.3 53,335 Cost rationalisation, improving revenue growth to EBIT Margin (%) 24.6 25.4 80 bps 25.1 26.2 110 bps 26.5 drive margins PAT 31,377 32,245 2.8 35,429 38,368 8.3 43,604 EPS (|) 83.6 87.2 4.3 94.4 103.8 9.9 118.0

Source: Company, ICICI Direct Research

ICICI Securities | Retail Research 2 Result Update | Tata Consultancy Services ICICI Direct Research

Conference Call Highlights

 Revenue outlook – TCS’ Q2FY21 revenues have sharply bounced back on the back of a healthy demand pick-up across verticals and geographies. The company has also seen market share gains via vendor consolidation opportunities. TCS also saw healthy growth in deal wins. The company was expecting normalisation of revenues and margins in H2FY21E. However, TCS has seen normalisation of revenues and margins in Q2FY21 itself. Further, considering healthy growth in deals, traction in digital and technology becoming an integral solution of business across geographies & verticals, we expect robust revenue growth to pan out in the coming years for TCS. Hence, although we expect a marginal dip in FY21E dollar revenues, we expect the company to clock double digit revenue growth in FY22E and FY23E

 Vertical wise commentary – The company saw healthy traction in BFSI and especially in capital markets. TCS also saw healthy growth in retail especially essential retail, which increased its investment in ecommerce and cybersecurity. The company expects investment in digital technologies across verticals and expect technology investment in customer experience, employee experience and business transformation to gain traction across verticals

 Margins – The company expects margins to be impacted by furloughs and wage hike in Q3FY21E. We expect TCS to report an 82 bps increase in FY21E margins. The company believes that with improving growth it can reach its aspirational goal of 26-28% band. However, we assume the company’s margins would be closer to the lower end of the margin band in FY22E and FY23E

 Digital business – TCS has discontinued giving break-up between digital and non-digital citing blurring lines between the two parts of businesses. However, it indicated that digital technologies are gaining traction and could be the key driver of growth in the long term. The company sees cloud, cybersecurity and automation as key drivers of digital technologies. Further, TCS is also seeing traction in customer experience, employee experience and business transformation. Further, accelerating investment in digital and core transformation will be key driver of technology in coming quarters

 Deal TCV - Deal TCV was at US$8.6 billion, up 24.6% QoQ and up 34.4% YoY. We believe this was mainly due to the company’s deal win in insurance segment and closure of earlier period large deal. The company has seen many smaller size & medium size deals in this quarter. The deal wins are also broad-based participation across top clients. Of the total TCV, North America accounted for $2.3 billion among geographies while vertically $1.7 billion was from BFSI and $1 billion in retail. The company is seeing healthy deal pipeline and is seeing no delay in decision making

 Client metrics - The company count in $100 million+ bucket increased by two YoY to 49. Three clients were added in the US$20 million+ and 44 in the US$1 million+ revenue bucket taking the total to 1076

 Employee update - Attrition in IT services declined 220 bps QoQ to 8.9% (LTM). There was an increase of 9864 employees in this quarter. Employee strength was at 453,540 at end of Q2FY21. The company has hired 7000 freshers in the current quarter and is aiming to hire 12000 employees in Q3FY21E. TCS is also planning to give a wage hike in H2FY21E. The company still has only 3% of employees working out of office

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Key Metrics

Exhibit 3: Geography wise break-up Q 1F Y20 Q 2F Y20 Q 3F Y20 Q 4F Y20 Q 1F Y21 Q 2F Y21 Revenue by geography (%) North America 50.6 50.6 50.1 50.3 51.4 49.9 Latin America 1.8 1.9 1.9 1.8 1.7 1.7 UK 15.8 15.6 15.9 16.0 15.3 15.5 Continental E urope 14.3 14.6 14.9 15.2 15.6 16.3 India 6.0 5.7 5.7 5.5 4.3 5.0 Asia Pacific 9.4 9.4 9.3 9.3 9.8 9.7 Growth happened across geographies and was led MEA 2.1 2.2 2.2 1.9 1.9 1.9 by Americas and Europe

Growth QoQ (%) North America 1.4 0.6 0.3 -2.2 -5.0 4.1 Latin America -8.5 6.2 1.3 -7.7 -12.2 7.2 UK 1.0 -0.7 3.2 -1.9 -11.1 8.6 Continental E urope 3.1 2.7 3.3 -0.6 -4.6 12.0 India 5.1 -4.4 1.3 -6.0 -27.3 24.7 Asia Pacific 0.6 0.6 0.2 -2.5 -2.1 6.1 MEA 6.7 5.4 1.3 -15.8 -7.1 7.2

Source: Company, ICICI Direct Research

Exhibit 4: Vertical wise break-up Q 1F Y20 Q 2F Y20 Q 3F Y20 Q 4F Y20 Q 1F Y21 Q 2F Y21 Revenue by verticals (%) BFSI 30.8 31.3 30.4 29.7 31.5 31.9 Retail & CPG 15.0 14.8 15.2 15.4 14.0 14.6 Communication and Media 6.9 6.9 7.0 7.2 6.9 6.5 BFSI and retail led the growth in verticals Manufacturing 9.8 9.8 10.0 10.1 9.7 9.4 Life Sciences & Healthcare 7.9 8.1 8.3 8.8 9.6 9.8 Technology & services 8.8 8.7 8.4 8.7 9.1 8.9 Regional markets & others 20.8 20.6 20.7 20.1 19.2 18.9

Growth QoQ (%) BFSI 1.3 2.2 -1.7 -4.8 -1.4 8.6 Retail & CPG 1.0 -0.8 4.0 -1.3 -15.5 11.8 Communication and Media 3.1 0.6 2.7 0.2 -10.9 1.0 Manufacturing 3.7 0.6 3.3 -1.6 -10.8 3.9 Life Sciences & Healthcare 4.3 3.1 3.8 3.3 1.4 9.4 Technology & services 4.0 -0.6 -2.2 0.9 -2.8 4.9 Regional markets & others -0.8 -0.4 1.7 -5.4 -11.2 5.5

Source: Company, ICICI Direct Research

Exhibit 5: Client & human resource matrix Q 1F Y20 Q 2F Y20 Q 3F Y20 Q 4F Y20 Q 1F Y21 Q 2F Y21 Client metrics USD 1 mn+ clients 1014 1032 1053 1072 1066 1076 The company added one client in US$100 million USD 5 mn+ clients 551 554 557 565 564 565 category and added 9864 employees in the current USD 10 mn+ clients 384 398 395 391 382 386 quarter USD 20 mn+ clients 219 225 232 240 230 228 USD 50 mn+ clients 100 101 102 105 100 97 USD 100 mn+ clients 44 47 47 49 48 49

Headcount, Attrition Total E mployees 436641 450738 446675 448646 443676 453540 Attrition, LTM (IT Services) 11.5 11.6 12.2 12.1 11.1 8.9

Source: Company, ICICI Direct Research

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Financial story in charts

Exhibit 6: Dollar revenues may grow at 6.8% CAGR in FY20-23E 35 33000 26835 28000 24082 28 20913 22032 21880 23000 19089 21 1654417575 18000 10.0 10.0 10.1 11.4 % 8.6 9.7 8.5 9.6 8.6 14 7.1 13000 6.2 5.8 6.4 5.4 $ million 5250 5517 7 8000 50515215 5397 5485 558654440.9 50595424

3000 0

FY17 FY18 FY19 FY20 FY16

FY21E FY23E FY22E

Q2FY19 Q3FY19 Q1FY20 Q4FY20 Q2FY21 Q1FY19 Q4FY19 Q2FY20 Q3FY20 Q1FY21

Dollar revenues Growth, YoY

Source: Company, ICICI Direct Research

Exhibit 7: Revision in margin estimates for FY21E, FY22E & FY23E 30

28 26.5 26.5 26.2 26.2 26.5 25.7 25.6 25.6 25.4 26 25.0 25.1 25.0 25.1 24.8 24.6 % 24.2 24.0 23.6 24

FY17 FY16 FY18 FY19 FY20

FY21E FY23E FY22E

Q1FY19 Q2FY19 Q4FY19 Q1FY20 Q3FY20 Q4FY20 Q1FY21 Q3FY19 Q2FY20 Q2FY21 EBIT Margin

Source: Company, ICICI Direct Research

Exhibit 8: PAT trend

47000 43604

40000 38368

32340 32245

33000 31472

26289 25826 26000 24215

19000| crore

8693

8131

8125

8118

8105

8049 8043

12000 7901

7340 7008

5000

FY19 FY16 FY17 FY18 FY20

FY23E FY21E FY22E

Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q1FY19 Q2FY19 Q4FY20 Q1FY21 Q2FY21 Net Profit

Source: Company, ICICI Direct Research

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Exhibit 9: Three year price chart

15,000 3,000 13,000 2,500 2,000 11,000 1,500 9,000 1,000 7,000 500

5,000 0

Jun-18 Jun-19 Jun-20

Sep-17 Sep-18 Sep-19 Sep-20

Dec-17 Dec-18 Dec-19

Mar-18 Mar-19 Mar-20

Nifty (L.H.S) Price (R.H.S)

Source: Company, ICICI Direct Research

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Financial summary

Exhibit 10: Profit and loss statement | crore Exhibit 11: Cash flow statement | crore (Year-end March) F Y20 F Y21E F Y22E F Y23E (Year-end March) F Y20 F Y21E F Y22E F Y23E Total operating Income 1,56,949 1,61,911 1,78,204 2,01,263 Profit before Tax 42,248 43,711 50,097 56,915 G rowth (% ) 7.2 3.2 10.1 12.9 Add: Depreciation 3,529 3,886 4,277 4,830 COGS (employee expenses) 89,635 92,613 1,00,507 1,13,311 (Inc)/dec in Current Assets -7,125 7,766 -4,401 -6,687 S,G&A expenses 25,204 24,287 26,731 29,787 Inc/(dec) in CL and Provisions 2,625 862 2,850 4,036 Total Operating E xpenditure 1,14,839 1,16,900 1,27,237 1,43,098 Taxes paid -5,846 -10,141 -11,623 -13,204 EBITDA 42,110 45,011 50,966 58,165 CF from operating activities 35,391 42,231 38,193 42,709 G rowth (% ) 6.6 6.9 13.2 14.1 (Inc)/dec in Investments 7,707 -1,530 -489 -692 Depreciation 3,530 3,886 4,277 4,830 (Inc)/dec in Fixed Assets -3,088 -3,238 -3,564 -4,025 Other Income less interest 3,668 2,585 3,408 3,581 O thers 0 2,635 3,008 3,181 PBT 42,248 43,711 50,097 56,915 CF from investing activities 4,619 -2,133 -1,045 -1,536 Total Tax 9,801 10,141 11,623 13,204 Inc/(dec) in loan funds 0 0 0 0 Minority Interest 107 107 107 107 Dividend paid & dividend tax -37,634 -15,597 -34,629 -38,684 O thers -295 -16,000 0 0 P AT 32,340 32,245 38,368 43,604 C F from financing activities -38,991 -31,597 -34,629 -38,684 G rowth (% ) 2.8 -0.3 19.0 13.6 Net Cash flow 1,019 8,500 2,519 2,489 E P S (|) 86.2 87.2 103.8 118.0 E xchange difference 0 0 0 0 P AT 32,340 32,245 38,368 43,604 Opening Cash 7,224 9,799 18,299 20,818 E PS - Reported (|) 86.2 87.2 103.8 118.0 Closing cash and Bank 9,799 18,299 20,818 23,307

Source: Company, ICICI Direct Research Source: Company, ICICI Direct Research

Exhibit 12: Balance sheet | crore Exhibit 13: Key ratios | crore (Year-end March) F Y20 F Y21E F Y22E F Y23E (Year-end March) F Y20 F Y21E F Y22E F Y23E Liabilities Per share data (|) E quity Capital 375 370 370 370 Adjusted E PS (Diluted) 86.2 87.2 103.8 118.0 Reserve and Surplus 81,932 82,585 86,324 91,244 BV per share 230.0 235.0 245.2 258.5 Share Premium 3,933 3,933 3,933 3,933 DPS 85.0 42.2 93.7 104.6 Total Shareholders funds 86,240 86,888 90,626 95,546 Cash Per Share 26.1 49.5 56.3 63.0 Total debt 8,174 8,214 8,346 8,532 Operating Ratios (%) O ther liabilities & Provisions 1,405 1,636 1,701 1,793 E BIT margins 24.6 25.4 26.2 26.5 Deferred tax liability(net) 779 779 779 779 PBT Margins 26.9 27.0 28.1 28.3 Minority Interest / O thers 623 730 837 944 P AT Margin 20.6 19.9 21.5 21.7 Total Liabilities 97,221 98,246 1,02,289 1,07,595 Debtor days 71 68 68 68 Creditor days 16 16 16 16 Assets Return Ratios (%) Net assets & CWIP 20,215 19,567 18,855 18,049 R oE 37.5 37.1 42.3 45.6 G oodwill 3,850 3,850 3,850 3,850 R oC E 43.5 44.5 49.0 52.9 Other non current assets 7,965 9,495 9,984 10,676 R oIC 63.0 76.4 84.4 91.7 Debtors 30,606 30,277 33,324 37,636 Valuation Ratios (x) Loans and Advances 10,171 8,096 8,910 10,063 P/E 31.7 31.3 26.3 23.2 Other Current Assets 14,267 8,905 9,445 10,667 EV / Net Sales 6.4 6.1 5.5 4.9 Current Investments 26,140 26,140 26,140 26,140 Market Cap / Sales 6.5 6.3 5.8 5.1 C ash 9,799 18,299 20,818 23,307 Solvency Ratios Trade Payable 6,740 6,953 7,653 8,643 Debt / EBITDA 0.2 0.2 0.2 0.1 OCL & Provisions 19,052 19,431 21,384 24,152 Debt / E quity 0.1 0.1 0.1 0.1 Application of F unds 97,221 98,246 1,02,289 1,07,595 Current Ratio 2.1 1.8 1.8 1.8

Source: Company, ICICI Direct Research Quick Ratio 2.1 1.8 1.8 1.8

Source: Company, ICICI Direct Research

ICICI Securities | Retail Research 7 Result Update | Tata Consultancy Services ICICI Direct Research

Exhibit 14: ICICI Direct coverage universe (IT) EP S (|) P /E (x) RoCE (%) RoE (%)

Com pany Cm p (|) TP (|) Rating Mcap (| Cr) F Y20 F Y21E F Y22E F Y21 F Y22 F Y20 F Y20 F Y21 F Y22 F Y20 F Y21E F Y22E E E E E HCL Tech (HCLTEC) 828 885 Hold 2,19,368 40.8 46.3 52.5 20 18 16 23.0 23.0 23.2 21.6 20.5 19.8 Infosys (INFTE C) 1,067 1,000 B uy 4,38,701 38.9 43.3 50.3 27 25 21 30.8 31.6 33.4 25.2 25.7 27.0 TC S (TC S ) 2,737 3,300 B uy 10,26,375 86.2 87.2 103.8 32 31 26 43.5 44.5 49.0 37.5 37.1 42.3 Tech M (TECMAH) 846 765 B uy 76,338 45.9 44.0 51.0 18 19 17 19.1 16.4 17.4 18.5 16.0 16.7 Wipro (WIPRO) 335 300 B uy 1,89,100 16.6 17.5 19.3 20 19 17 19.3 18.2 18.7 17.4 16.3 16.7 Mindtree (MINCON) 1,390 1,160 B uy 21,985 38.3 51.8 60.3 36 27 23 23.0 26.6 27.4 20.0 22.9 23.3 LTI (LTINFC) 2,670 2,320 Hold 44,095 86.6 97.1 113.6 31 27 23 30.7 29.2 29.2 28.1 26.4 26.2 Coforge (NIITE C) 2,401 2,200 B uy 13,759 71.4 75.3 94.4 34 32 25 23.0 24.7 26.0 18.5 19.4 21.2 Infoedge (INFE DG) 3,475 3,555 Hold 46,774 26.8 27.8 33.4 130 125 104 18.0 10.6 12.0 13.5 7.9 8.9 Teamlease (TEASER) 2,290 2,205 B uy 3,769 20.5 48.2 62.8 112 47 36 15.0 12.7 14.1 6.5 12.9 14.5

Source: Company, ICICI Direct Research

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RATING RATIONALE ICICI Direct endeavors to provide objective opinions and recommendations. ICICI Direct assigns ratings to its stocks according to their notional target price vs. current market price and then categorizes them as Buy, Hold, Reduce and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock Buy: >15% Hold: -5% to 15%; Reduce: -15% to -5%; Sell: <-15%

Pankaj Pandey Head – Research [email protected]

ICICI Direct Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC, Andheri (East) Mumbai – 400 093 [email protected]

ICICI Securities | Retail Research 9 Result Update | Tata Consultancy Services ICICI Direct Research

ANALYST CERTIFICATION

I/We, Devang Bhatt, PGDBM, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. It is also confirmed that above mentioned Analysts of this report have not received any compensation from the companies mentioned in the report in the preceding twelve months and do not serve as an officer, director or employee of the companies mentioned in the report.

Disclaimer in retail research report:

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