HSBC maintains a Hold rating, but with a higher target price of Rs 3200 (Rs 3050), largely driven by EPS upgrades. The stock trades at 30x/28x on FY22e/23e EPS. HSBC is assuming a 100bp decline in FY22e over Q3 FY21 margins, led by normalization of travel, visas, and other costs.
TCS reported a robust quarter with 4.1% qoq cc growth vs 2.5% consensus expectations. A surprise was the 40bp margin expansion qoq to 26.6% EBIT margin, despite a wage hike in the quarter. Management is confident in the demand environment and affirmed double-digit growth in FY22e. Management does not believe there was any budget flush in Q3, and, hence, thinks the strength seen in Q3 should continue in Q4.
HSBC was already expecting 12% growth in FY22e, but the Q3 beat has prompted HSBC to raise our growth estimate to 14%. HSBC expects a return to 8-9% growth in FY23e/24e. In HSBCs view, pandemic-led needs have resulted in an improved outlook for Indian IT over the next 3-4 years, as most customers have accelerated modernising plans and built further “resilience” into their IT infrastructure. HSBC continues to expect mega transformational deals as clients transfer end to end operations to IT companies. HSBC expects cloud adoption to remain the key underlying tech trend driving the digital and modernisation agenda, and the key monitorable data in 2021.
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Margins expanded in 3Q despite a wage hike impact of 160 bp qoq. Offshoring, in HSBC’s view, helped contain employee costs (up only 1.7% qoq), despite a +3% increase in headcount, 100% variable pay-outs and the wage hike. Higher utilization, record low attrition and favourable currency also contributed to the margin surprise. The total contract value (TCV) of deals signed in Q3 was USD 6.8 bn compared to past four quarters’ average of USD 7.6 bn. Banking verticals contributed USD 2.6 bn of the TCV (excluding the Post Bank deal). Growth was broad-based across verticals and regions. According to TCS’s CEO, “technology is the solution to all problems”, and is driving every client to spend more on technology – be it on business growth or operational cost-cutting. For banks (largest vertical), eg, tech spend will be driven by the move to cloud, wealth management investments and customer experience.
Estimates and valuation:
TCS is the largest and, HSBC thinks, one of the best managed IT companies in India; we continue to see it participating in the high tide of IT spend. However, considering what HSBC view as limited upside potential for revenues, margins and valuation, HSBC prefers to remain on the side-lines.