Investors are in two minds about TCS’ results.

With slow revenue growth in what is usually a seasonally strong quarter, investors are left wondering whether TCS will be able to post double-digit revenue growth in FY22. To put things in perspective, the company posted a muted 2.8% QoQ dollar revenue growth in Q1FY22, but because of the low base in Q1FY21 last year, the YoY growth in revenues in dollar terms is 21.6%.

So if over the next nine months of FY22 TCS’ revenues grow by at least 6.6% YoY in dollar terms, then it will manage to post at a minimum 10% YoY dollar revenue growth. TCS’ dollar revenues had risen by just 0.6% YoY in FY21 due to the pandemic related disruption caused in H1FY21.

However, investors would be hoping for something more than just a 10% YoY dollar revenue growth in FY22, and the muted Q1FY22 revenue growth in Q1 raised some concerns - is this an early warning sign? As a result the company’s stock has been wobbly over the past few trading sessions. The stock is currently trading at nearly 35 times its trailing twelve month earnings per share.

But how did TCS’ various verticals and regions fare over the three months ended June 2021? And what does that tell us about the way forward?

Profit slips on salary hikes, India lockdowns stem revenue growth

It is unusual for an Indian IT services company to point at their revenues from India slowing overall growth, but that is what TCS’ management said in their Q1FY22 earnings call with analysts. The lockdowns in many states in India due to the second wave of the Covid-19 pandemic caused dollar revenues to fall 15.6% QoQ for the region. The company said this is more a deferral of revenues, which it will be able to make up over the course of the year.

In FY21, TCS delayed pay hikes from Q1FY21 to later in the year because of the uncertainty caused by the pandemic. But regular service resumed in Q1FY22 as the company undertook pay hikes for its employees during the quarter.

The pay hikes caused employee costs to rise by 8.6% sequentially during the quarter to Rs 25,649 crore, which led the net consolidated net profit to fall by 2.6% QoQ to Rs 9,008 crore. This caused a 1.7 percentage points QoQ erosion in earnings before interest and tax (EBIT) margins, which was offset partly by the depreciation of the rupee. The company also saw some discretionary expenses like travel return in Q1FY22 as some parts of the world returned to normalcy.

IT services employee attrition inched up to 8.6% in Q1FY22 from an all-time low of 7.2% in Q4FY21. This shows that there is intense demand for talent with digital skills. The company plans to hire 40,000 trainees and is training its existing 5 lakh+ employees in new age skills to make sure there are no supply-side issues in the future as projects come on stream.

Some verticals return to normalcy; record deal wins in Q1FY22

When the pandemic started last year and led to lockdowns across the world, manufacturing activity took a hit. This impacted IT services companies’ revenues from manufacturing verticals, which fell considerably. In Q3FY20 TCS’ manufacturing vertical’s revenues were $ 550 million. In FY21, this vertical’s quarterly revenues did not cross that level till Q4FY21.  

Although the retail & CPG (consumer product group) vertical’s revenues recovered in H1FY21, its numbers were also severely impacted by the pandemic and fell sequentially in Q4FY20 and Q1FY21, and ended above the Q3FY20 revenues ($ 849 million) only by the end of Q4FY21.

This is why two consecutive quarters of 5% QoQ growth in revenues for manufacturing and retail & CPG verticals bodes well for TCS. It will be interesting to see how this pans out in the subsequent quarters.

The life sciences and healthcare vertical grew at a rapid pace of 8.1% QoQ in Q1FY22 and the company and the mainstay BFSI (banking, financial services and insurance) vertical also posted decent growth crossing the $ 2 billion revenue threshold for the first time in Q1FY22.

Another factor that will enthuse investors in TCS is the highest ever Q1 total contract value of deals bagged in Q1FY22 worth $ 8.1 billion. This gives it a decent revenue runway over the next few quarters. The management said that some newer large deals are of a longer duration of multiple years. The thrust in the new deals continues to be migration from mainframes to cloud servers, and machine learning and artificial intelligence capability building.

Management reiterates multi-year IT spending cycle

From last year onwards, IT services companies, including TCS are projecting a multi-year IT spending cycle which led to their shares being traded above their five year average PE multiples. TCS’ management reiterated this during the Q1FY22 earnings call.

For investors in IT services companies, the large deal TCV might confirm the argument that this trend is playing out. But there is intense competition for talent, with high demand for skills related to digital capabilities.

This means there is a possibility of higher salary costs across the board for the industry, and TCS will not be immune to this phenomenon. TCS is trying to maintain enough bench strength with relevant skills to be able to deploy the workforce as and when new projects come on stream.

But to maintain its margins within its aspirational 26-28% band over the next few years, the company will need to post at least double-digit revenue growth. The management points out that revenue growth will be the catalyst for higher margins over the next few years. This depends on the company continuing to bag large deals and converting it into revenues consistently. It will be interesting to see how TCS’ peers fare when they declare their results over the next few days.