Result Update January 13, 2017 Rating matrix Rating : Hold Tata Consultancy Services (TCS) | 2250 Target : | 2465 Target Period : 12 months Potential Upside : 9% Strong execution in weak environment… What’s Changed? • US$ revenues grew 0.3% QoQ to $4,387 million, below our 1.0% Target Changed from | 2,600 to | 2,465 growth and $4,418 million estimate. Constant currency (CC) revenues EPS FY17E Changed from | 132.2 to | 135.2 grew 2% QoQ led by volumes (1% QoQ) and also helped by EPS FY18E Changed from | 144.7 to | 144.9 realisations (~100 bps) Rating Changed from Buy to Hold • Rupee revenues increased 1.5% QoQ to | 29,735 crore, marginally below our 1.7% QoQ growth and | 29,776 crore estimate Quarterly Performance Q3FY17 Q3FY16 YoY (%) Q2FY17 QoQ (%) • At 26.0%, EBIT margins remain unchanged QoQ led by operational Revenue 29,735 27,364 8.7 29,284 1.5 efficiency in a seasonally weak quarter offset by currency headwind EBIT 7,733 6,867 12.6 7,617 1.5 and was in line with our 26.1% estimate. PAT of | 6,778 crore was EBIT (%) 26.0 25.1 91 bps 26.0 0 bps ahead of our | 6,558.5 crore estimate led by higher other income PAT 6,778 6,110 10.9 6,586 2.9 • TCS announced an interim dividend of | 6.5/share BFSI & retail perform well; expected to perform well in CY17… Key Financials Despite a seasonally weak quarter, BFSI (40.4% of revenue) grew 2.1% | Crore FY15 FY16 FY17E FY18E QoQ in CC terms above the company average of 2% QoQ growth in CC. Net Sales 94,648 108,646 118,928 129,233 Retail (13.5% of revenue) bounced back with 1.9% QoQ CC growth post a EBITDA 24,666 30,678 32,724 35,798 decline in Q2FY17 and is expected to maintain its momentum in the Net Profit 19,648 24,215 26,640 28,563 EPS (|) 100.3 123.2 135.2 144.9 coming quarters. Communications & media (10.6% of revenue) declined 4.9% QoQ. The management expects this to be a one-off and could *FY15 recurring PAT Valuation summary report steady growth in coming quarters. The management sounded FY15 FY16 FY17E FY18E optimistic regarding spends, especially on the BFSI side for CY17 yet P/E 25.2 18.4 16.8 15.7 budgets are still to be finalised. The management expects TCS to win Target P/E 27.4 20.1 18.3 17.1 market share consolidation opportunity and continue its momentum to EV / EBITDA 17.2 14.2 13.2 12.0 win a fair share of digital spends among customers. We now expect dollar P/BV 7.7 6.1 5.0 4.3 revenue to grow 6.6%, 7.9% in FY17E, F18E, respectively. RoNW (%) 34.2 33.1 30.1 27.1 Strong performance at margin level; maintains 26-28% margin band… RoCE (%) 61.2 46.2 43.1 39.6 At 26.0%, EBIT margins stayed unchanged QoQ led by a strong operational performance despite weak quarter and in line with 26.1% Stock data estimate. The management highlighted the US may change visa Particular Amount regulations like visa fee or number of visa applications. TCS proactively Market Capitalization (| Crore) 442,666.2 hired US locals in last few years, evident from one-third of visa Total Debt (| Crore) 196.0 applications in CY16 vs. CY15 and intends to hire more freshers in US Cash and equivalents (| Crore) 29,517.5 EV (| Crore) 415,937.1 along with laterals to mitigate any visa regulations change, going ahead. 52 week H/L 2740 / 2055 Hence, we tweak our margin estimate to 25.9% each in FY17E, FY18E. Equity capital 195.9 Change in leadership… Face value | 1 TCS’ current CFO Rajesh Gopinathan has been appointed the new MD and CEO succeeding current CEO N Chandrasekaran. N Chandrasekaran Price performance (%) has been appointed the Chairman of Tata Sons, effective February 21, 1M 3M 6M 12M 2017. NG Subramaniam, currently President (TCS Financial Solutions) has TCS 3.7 (1.7) (7.1) (4.5) been named President and COO and been appointed a director on the Infosys (3.4) (8.2) (17.8) (9.2) TCS board. Wipro 2.9 0.3 (15.7) (13.7) HCL Tech 1.3 3.5 16.0 0.4 Revising recommendation to HOLD with target price of | 2465… We are marginally revising our earnings estimates for FY17E & FY18E Research Analyst factoring in an uncertain macro environment. We are lowering the multiple by a notch owing to growing protectionism among geographies, Deepak Purswani, CFA [email protected] which could impact margins and leadership changes given the outstanding credentials of leaving CEO N Chandrasekaran. Consequently, Tushar Wavhal we value TCS at 17x FY18E EPS of | 144.9 to arrive at our revised target [email protected] price of | 2,465. We estimate rupee revenue, PAT CAGR of 9.1%, 8.6% in FY16-18E (average 25.9% EBIT margins in FY16-18E), vs. 23.8%, 22.8% Deepti Tayal reported in FY11-16, respectively. [email protected] ICICI Securities Ltd | Retail Equity Research Variance analysis Q3FY17 Q3FY17E Q3FY16 YoY (%) Q2FY17 QoQ (%) Comments Constant currency revenues grew 2.0% QoQ led by volumes (1%) and helped by Revenue 29,735 29,776 27,364 8.7 29,284 1.5 price realisation Employee expenses 16,514 16,406 15,292 8.0 16,171 2.1 Gross Margin 13,221 13,369 12,072 9.5 13,113 0.8 Gross margin (%) 44.5 44.9 44.1 35 bps 44.8 -32 bps SG&A expenses 4,992 5,092 4,734 5.4 5,002 -0.2 EBITDA 8,229 8,278 7,338 12.1 8,111 1.5 EBITDA Margin (%) 27.7 27.8 26.8 86 bps 27.7 -2 bps Depreciation 496 506 471 5.4 494 0.4 EBIT 7,733 7,771 6,867 12.6 7,617 1.5 EBIT margins remain unchanged QoQ led by operational efficiency offset by EBIT Margin (%) 26.0 26.1 25.1 91 bps 26.0 0 bps currency headwind Other income (less interest) 1,185 858 699 69.5 1,052 12.6 PBT 8,918 8,629 7,566 17.9 8,669 2.9 Tax paid 2,104 2,054 1,850 13.7 2,066 1.8 PAT 6,778 6,558 6,110 10.9 6,586 2.9 Reported PAT was ahead of our estimate due to higher other income Key Metrics Closing employees 378,497 365,000 344,691 9.8 371,519 1.9 6,978 net heads were added sequentially Overall attrition (%) 12.2 14.0 15.9 -370 bps 12.9 -70 bps Attrition has continued its downward trajectory Average $/| 67.8 67.4 66.0 2.7 67.0 1.2 Source: Company, ICICIdirect.com Research Change in estimates FY17E FY18E (| Crore) Old New % Change Old New % Change Comments Revenue 118,327 118,928 0.5 129,883 129,233 -0.5 EBIT 31,727 30,747 -3.1 35,148 33,459 -4.8 EBIT Margin (%) 26.8 25.9 -96 bps 27.1 25.9 -117 bps PAT 26,048 26,640 2.3 28,510 28,563 0.2 EPS (|) 132.2 135.2 2.3 144.7 144.9 0.2 We have tweaked our estimates to reflect Q3FY17 performance Source: Company, ICICIdirect.com Research Assumptions Current Earlier FY15 FY16 FY17E FY18E FY17E FY18E Closing employees 319,656 353,843 374,920 389,930 367,843 403,702 Overall attrition (%) 16.0 17.5 11.0 12.0 13.0 12.0 Average $/| 61.2 65.7 67.0 67.5 67.0 67.5 Source: Company, ICICIdirect.com Research ICICI Securities Ltd | Retail Equity Research Page 2 Company Analysis Key highlights: Commentary from earnings call • Management changes: TCS’ current CFO Rajesh Gopinathan has been appointed the new MD and CEO succeeding current CEO N Chandrasekaran. N Chandrasekaran has been appointed the Chairman of Tata Sons, effective February 21, 2017. NG Subramaniam who is currently President (TCS Financial Solutions) has been named President & COO and been appointed a director on the board of TCS. • India business increased 10.3% QoQ in CC terms on account of orders worth ~| 180 crore spilling over to Q3 from Q2 leading the growth • Retail segment (13.5% of revenue) bounced back to 1.9% in CC terms. This is expected to perform well in Q4FY17E also • Sequentially, the digital business contributed 16.8% to revenue (13.7% in Q3FY16), up 6.6% QoQ, 30.2% YoY • The management sounded optimistic on BFSI spend, which was muted in recent quarters. They expect the digital space to expand significantly in CY17E with TCS winning larger spend among other vendors. They trained close to 190,000 employees in newer technologies, which could drive growth in the digital segment, going ahead • The management expects Q4FY17E to be better than Q3FY17 following traditional momentum • The company clocked greater than US$ 1 billion quarterly run rate of net profit and cash flow from operations • It added two and five clients in the US$50 million+ and US$10 million+ bucket, respectively • Net addition during the quarter was at 6978 associates (9MFY17 net additions were at 24,654) with closing headcount of 378,497 • LTM attrition improved further QoQ to 11.3% in IT services with 12.2% including business process services (BPS) Operating metric highlights: India increases 7.6% QoQ… US$ revenues grew 0.3% QoQ to $4,387 million and was below our 1% QoQ growth and $4,418 million estimate.