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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
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
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 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
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
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
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.