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Is It a Good Time to Buy TCS? 👩‍💻

The US and Europe have been going through an economic downturn. But TCS, which depends on these two economies for most of its business saw its revenue grow by 15.4% YoY. Is it a good time to bet on TCS despite all the global weaknesses?


Shining in the Coal Stack

TCS announced its quarterly results, and the numbers were a beat on all counts!

  • Revenue grew by 4% QoQ (an acceleration from 3.5% in the previous quarter)

  • Growth remained strong even in verticals that would ideally have been negatively impacted - banking grew by 13% YoY, and manufacturing by 15%

  • Geographic performance too was broad-based as the US grew by 18% YoY, the UK by 15% and Europe by 14%

  • Its order book remained strong at US$ 8.1 billion, steady despite all the global weakness

  • EBIT margins expanded by 90 bps QoQ to 24% as the rupee depreciated

Tech Stocks in the Red

Since global macroeconomic conditions started to worsen, the IT sector has been one of the worst-performing industries. After all, most of the Indian IT revenues depend on the US and Europe.


Historically, there has been a very high correlation between these economies' performance, and the operating performance of Indian IT stocks.


This was seen in 2008, 2012 and even in 2015, when the Indian IT sector went through rough patches, led by a weak global environment.


This year too, in 2022 so far (January 1, 2022 - October 10, 2022), IT stocks have all fallen anywhere between 16% and 42%.


Why Is TCS Holding Up?

While all IT stocks have been underperformers, TCS has lost the least value, losing only 16% when compared to its peers. Several factors have contributed to this performance:

  1. TCS has relatively lower client concentration compared to its peers, which makes it less prone to disaster if one of the large clients goes down

  2. Its revenue streams too are well diversified across industry verticals and geographies, which again protects it from a downfall in a particular industry

  3. TCS has a stable leadership and management team, which makes it better placed to cut through during tough times

  4. It has been at the forefront when it comes to newer technologies, the demand for which is relatively shielded compared to the demand for traditional services

  5. The services TCS has been focusing on are those that its clients need to spend on irrespective of market conditions, which makes its deal pipeline and order book more resilient

  6. Given its size and scale, TCS is able to better manage its cost structures and is less prone to margin pressures compared to its peers

  7. It has demonstrated an ability to outperform peers in tough times even before; this isn't the first time TCS is coming out as a winner on gloomy days

Should You Invest in TCS?

Positive

  • We like TCS for the fact that it’s best-placed among all IT companies to ride the storm. Smaller companies, those with higher revenue concentration, or wobbly structures would be much more fragile during tough times. If one had to take a position in the IT sector, TCS would definitely be one of the more steady names.

  • Additionally, there are tailwinds for the sector in the form of high digital spending, strong offerings and positioning by Indian IT, and rupee depreciation.

Negative

  • However, the IT sector may go through its fair share of pain. Rising rates have just about started impacting economic growth. The US and Europe have seen flat to negative GDPs for just a quarter or two.

  • Earnings forecasts for the US have been declining, but are still positive for the next quarter. In some ways, the impact of the economic slowdown trickling down on IT budgets, and consequently on the performance of Indian IT companies may still take time to be seen in full force.

💡 Our View - We think there is more pain ahead for the IT sector, in the near term. However, when quality stocks get available at low valuations, they can be bought into for the long term. After all, we are optimistic about the sector’s prospects over the long run.


Disclaimer - TCS is part of the Rocketship portfolio, Infosys is in Bread & Butter, and Tech Mahindra is in Socially Responsible Investing.

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