Bengaluru: The squabble between rival factions owing allegiance to Cyrus Mistry and Ratan Tata at the Tata group could mask the potentially poor performance of individual companies. Tata Consultancy Services Ltd (TCS) could be one beneficiary.
According to BNP Paribas, TCS will report a 6% increase in dollar revenue in the current financial year, down from last year’s 7%. Even this projection looks a tad generous, and, according to Mint calculations, TCS runs the risk of less than 5.6% growth.
Put simply, TCS, for the first time since it clocked 5.4% growth in 2009-10, could add less than $1 billion in incremental revenue this year. And that could ring alarm bells at TCS, which ended with $16.5 billion in revenue in the financial year to March last year.
TCS will report its fiscal third quarter earnings on Thursday.
Accenture Plc., a firm about twice as large as TCS, recorded 6% growth in the year ended August (Accenture follows a September-August financial year). Nasdaq-listed Cognizant Technology Solution Corp., which was about half of TCS’s size of $6 billion in 2009—when Natarajan Chandrasekaran became the CEO of TCS—will still manage 9% growth to end the year with at least $13.5 billion in revenue (Cognizant follows the calendar year as financial year).
At the heart of TCS’s underperformance, which started manifesting in July 2014, is its inability to build a stronger consulting practice and the management’s reluctance to buy small firms for technologies like design consulting and data analytics and automation platform providers. TCS also faces some client-specific challenges, all of which have led to low growth. Still, over the last two years, this has not stopped TCS management from claiming the company is making itself future-ready. The biggest concern for stakeholders is if TCS will continue to chug along in 2017-18 and disappoint with depressing growth numbers. For now, the signals are not bright.
With this as the backdrop, Mint puts the spotlight on five things to watch in TCS’s third quarter earnings on 12 January:
1. Revenue growth and management commentary on the demand outlook
BNP Paribas expects TCS’s dollar revenue to inch up 0.3% to $4.39 billion in the October-December period on a sequential basis. Most brokerages do not expect any significant uptick in growth in the current quarter, either. Nonetheless, management commentary on demand for company’s services from clients, especially in Europe and US, will be crucial.
2. Pressure on profitability
Since January last year, TCS’s operating margins have been under pressure. Its 26.1% Ebit (earnings before interest and tax) margin at the end of March quarter was 54 basis points less than margins at the end of October-December period of 2014. The company’s margins further contracted to 25.1% at the end of June quarter, and improved to 26% at the end of July-September period. Now, as commoditized deals come under further pricing pressure, traditional levers like going slow on hiring will not be enough to offset the gradual decline in profitability. For this reason, most analysts are doubtful if TCS will be able to operate in the management’s stated guidance of 26-28%.
3. Performance in the banking, financial services, and insurance (BFSI) and retail sectors
Accenture’s performance in the September-November period and management commentary suggests some weakness in business from clients in the BFSI sector. This spells trouble for a company like TCS, which generates more than 40% of its business from BFSI. Retail segment too has seen a decline, and for this reason, management commentary on BFSI and retail, which together bring about 54% of its total revenue, will be eyed.
4. Impact of US bill seeking to increase pay to employees with H1B visas
Earlier this month, a legislation demanding that outsourcing firms pay at least $100,000 a year to employees who work in the US was introduced in the Congress. Analysts and industry executive believe it could take up to a year before the US makes this a law. Washington’s demand that companies like TCS pay a minimum wage of $100,000 to employees with H1B visas could hurt profitability by 300-500 basis points, according to a 9 January note by JPMorgan Chase and Co. analyst Viju George. Management commentary on this will be watched.
5. Weak sectors and geographies
TCS does not expect growth to rebound in Japan. The company claims to have arrested any loss of business from its UK-based insurance platform Diligenta. Growth from telecoms segment continue to be wobbly. Together, underperformance by the three units eroded about 2% growth from the company’s 11.9% growth on constant currency basis in 2015-16. TCS needs to report some growth on a consistent basis if it expects to perform better in FY2017-18.