MUMBAI: In a recent update, Tata Consultancy Services Ltd (TCS), a leading IT service provider, reported its earnings for the September quarter (Q2FY25). The performance has been characterized as subdued, raising concerns among investors and analysts alike.
The company’s sequential constant currency revenue growth came in at just 1.1%, slightly under the consensus estimate of 1.3%. This disappointing growth can be attributed to a weaker performance in the North American market, despite improvements in the low-margin BSNL project. The overall growth figures reflect a cautious demand landscape as clients remain selective in their spending.
TCS management highlighted challenges in the Life Sciences sector and specific accounts in the UK that negatively impacted the quarter’s results. Although there are indications of recovery in the Banking, Financial Services, and Insurance (BFSI) sector, clients continue to exhibit caution regarding discretionary expenditures, leading to a muted demand for IT services. The focus for many clients remains on cost transformation, which may prolong the recovery period.
Gradual Recovery Amid Challenges
According to analysts at ICICI Securities, TCSโs growth indicators have softened compared to Q1FY25, which experienced broader growth trends. The report, released on 11 October, signals ongoing geopolitical tensions and global macroeconomic uncertainties, contributing to a challenging market environment for TCS and its peers.
Deals Pipeline Performance
The total contract value (TCV) of deals won in Q2FY25 was reported at $8.6 billion, marking a decline of approximately 24% year-on-year. However, this figure aligns with the company’s internal comfort range of $7-9 billion. TCS leadership indicated that while the deal pipeline is approaching record levels, market volatility has resulted in longer deal closures. The delay in converting these deals into revenue growth poses a significant concern for investors, especially given the previous year’s inflated figures due to large mega deals.
Margins Under Pressure
One of the more significant disappointments was the earnings before interest and tax (EBIT) margin, which fell to 24.1%, a decline of 60 basis points from the previous quarter and considerably lower than the anticipated 24.9%. Increases in third-party expenses and subcontracting costs have primarily driven this reduction, although some benefit was seen from favorable currency fluctuations.
Earnings Downgrades Anticipated
The margin miss, coupled with a less optimistic outlook for the near future, has prompted several earnings downgrades for TCS. According to a report from Nomura Global Markets Research, while the BSNL project is expected to be a key revenue driver in the latter half of FY25, it could also hinder TCS’s ability to reach its aspirational margin band of 26-28%. The report, dated 10 October, noted adjustments to earnings per share projections, reducing them by 1.6% to 2.4% largely due to margin cuts.
Following suit, analysts at Prabhudas Lilladher have also adjusted their earnings estimates for FY25 and FY26 in light of the notable margin disappointment experienced in Q2.
Stock Market Reaction
As a response to the Q2FY25 results, TCS shares experienced a 1% decline in intraday trading on the National Stock Exchange. This drop reflects the impact of the earnings downgrades which dampened expectations of a swift revenue recovery. Year-to-date in 2024, TCS shares have underperformed the Nifty IT index, yielding returns of only 11%. Notably, TCS’s stock trades at a multiple of 27 times the FY26 price-to-earnings, as highlighted by ICICI Securities.
Although valuations have eased from recent highs, analysts caution that further declines may occur if low earnings growth trends persist, suggesting a need for TCS to demonstrate improved performance to assuage investor concerns and stabilize its stock price going forward.
