Analysts have largely welcomed Tata Consultancy Services Ltd’s first-quarter results, but have been left disappointed by the sharp dip in the company’s profit margin.
The country's largest IT services company Tata Consultancy Services (TCS) on Wednesday reported a a 12.6% increase in its revenue and 16.8% y-o-y increase in its net profit. Sequentially, this translated to a 0.7% increase in the top line and an 2.8% dip in the bottom line.
However, the company disappointed the Street on EBIT or earnings before interest and tax – a key measure of profitability which strips away the impact of non-operational factors such as tax and interest rate fluctuations and gives a more accurate picture of the company’s performance.
This time, the Mumbai-based company’s EBIT fell to 23.2% of sales from 24.5% in the preceding quarter. However, it was clearly better than the 18.8% margin posted in the year-ago period.
Speaking to the media on Wednesday, the company had blamed the margin dip on salary hikes that came into effect on April 1.
Indeed, the IT sector has been seeing intense competition for talent, and companies like TCS and Infosys have been forced to roll out steep salary hikes to retain their employees.
The ‘war for talent’ has, however, eased off in recent months with global uncertainties impacting the companies’ new order wins and forcing them to be more prudent in making job offers.
For its part, TCS said it gave salary hikes of 12-15% on April 1 for exceptional performers. This is higher than the traditional 6-10% hikes that IT companies give on an average, indicating that the company continues to be on the guard against poaching of its employees by talent-hungry rivals.
Despite the fierce competition in the job market easing off, analysts are not expecting a sudden jump in the company’s profit margins due to the overall cautious atmosphere in the industry.
Nomura, for example, said the EBIT margin is likely to improve only by around 0.1 to 0.5 percentage points this year due to two reasons: Weak growth and lack of scope to further cut down on the use of sub-contractors.
The company had resorted to sub-contracting some of its work during the last two years as it was not able to find enough in-house staff to deal with the surge in orders. However, this comes at a cost, as contract employees typically cost much more than in-house staff. With demand easing off, the company has successfully reduced its dependence on contract workers over the last three quarters.
TCS has also started going slow on hiring new employees. It added just over 500 employees to its workforce in the first quarter, compared to 14,136 added in the same quarter a year ago. The company has a target of adding 40,000 freshers to its rolls this year.
Some of the easing of the talent-crunch was visible in the form of a lower attrition rate – a measure of what percentage of the company’s employees left it to pursue other opportunities in the previous 12 months. The attrition rate for the June quarter was at 17.8%, down from 20.1% three months earlier.
TCS said it expects to reach its ‘normal’ levels of attrition by the second half of the current financial year, or some time between October this year and March next year.
TEMPERED EXPECTATIONS
TCS’ April-June performance was largely in line with Street expectations, except for on the revenue front. The company was widely anticipated to post a modest revenue increase of around 0.2%-0.3% on a sequential basis, but ended up reporting a flat revenue performance.
The company’s guarded commentary about growth for the rest of the year also caught analysts’ attention.
“TCS management’s guarded commentary around demand pick-up in the near term reflects a high level of uncertainty around discretionary projects in certain key verticals like banking, hi-tech and telecom,” pointed out ICICI Securities in its review of TCS’ results. “It could also be a function of accelerated technology spends, which global enterprises carried out post pandemic and are now rationalising amid higher scrutiny of technology budgets.”
The broker said it expects a “gradual pick-up in demand” for TCS for the remainder of the financial year, and sees overall revenue growth at 5.9% for the current year, compared to 13.7% last year.
“Our restraint is due to the uncertain demand outlook shared by TCS management in the near term for key verticals like banking, hi-tech and telecom,” the broker said, adding that it was “modestly tweaking” its estimates in light of the slightly underwhelming first quarter results.
However, it maintained a BUY rating on the stock and expects the stock to gain 16% in the next 12 months to Rs 3,780.
“Strong order booking momentum, large deal win announcements, macro recovery in key geographies like the US and EU, and release of pent-up demand in the coming quarters would help TCS get back to double-digit revenue growth in FY25,” it added.