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Read more about Investing in TCS? Street may be ignoring these three near-term headwinds on Business Standard. BFSI weakness, likely higher US tax rates and a strong rupee do not justify the stock\'s peak valuations

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investing in tcs street may be ignoring these

Investing in TCS? Street may be ignoring these

three near-term headwinds

The market capitalisation of Tata Consultancy Services (TCS) is close to the Rs 6-

trillion mark, with the company’s stock gaining 46 per cent over its 52-week low

of February last year. Half of the gains have come over the past month, and a

large part of those after the December quarter results. Given the sharp price rise,

the stock is trading at an expensive valuation of 20 times its FY20 estimates. The

near-peak valuations are at a 10-14 per cent premium to the target prices of

brokerages.

Analysts at Kotak Institutional Equities say that the stock is trading at full

valuations even after the recognition of potential cyclical uptick in business. The

stock has already reached the peak-cycle multiple, implying about 12 per cent

growth for the next 7-8 years.

while the street s enthusiasm after the results

While the Street’s enthusiasm after the results rests on a positive commentary on

the outlook both from TCS and other peers, a positive trend in deal signings and

strong traction in the high-growth digital segment, there are three risks to these

valuations.

The first is the weakness in the banking financial services and insurance (BFSI). In

addition to the retail vertical, BFSI has been the other key laggard for the Indian IT

services in recent quarters.

While the retail business for TCS looks like it is coming out of the woods, given the

six per cent sequential uptick in the quarter, BFSI, the largest vertical accounting

for over a third of overall revenues, continues to be a problem.

The vertical registered a revenue decline of 1.7 per cent. Analysts at HSBC say that

given the company was non-committal on the outlook for the BFSI space, this

would mean that growth for TCS will remain restricted to the 6-8 per cent range

until banking, which is a third of the business, picks up in earnest.

While some of the BFSI companies have not finalised on their budgets and are

holding back, what is a key negative is the trend of in-house implementation of IT

projects. This captive shift has led to the shrinking of budgets for existing projects

and could impact future projects as well.

The other negative is the additional tax burden under the new US tax regime.

Analysts believe that there could be a 100-basis-point increase in tax rates

resulting from the implementation of Base Erosion and Anti-abuse Tax (BEAT) in

the US.

Finally, what complicates the matter is the hardening of the rupee which will

impact revenues. Some analysts are factoring in Rs 64 a dollar in their estimates,

compared with Rs 65 earlier. Analysts at Credit Suisse believe that though TCS

margins have been stable, its FY18 margins are likely to fall short of its targeted

range of 26-28 per cent, with adverse currency movement being one of the

reasons.

While strong growth in all verticals barring BFSI is a positive and the 14 per cent

sequential revenue growth in digital services (22 per cent of revenues) should

help revenues, given the near-term headwinds, investors should be cautious

rather than run with the current momentum.