TCS warns on volumes and flat Q2 margins

Street darling Tata Consultancy Services (TCS) rattled analysts when it said volume growth was likely to be lower-than-expected in the second quarter (July-September) at 4.5-4.8% compared with the 5.3% seen in the first quarter.

Speaking at an analyst meet on Monday, chief financial officer S Mahalingam pinned the blame on the induction of freshers, ramp-up of projects from India, low-margins in Asia-Pacific and a marginal shift to onsite for new deal starts as the reasons for the expected slowdown.

It must also be noted that in the April-June quarter, TCS saw benefits come in from the ramping up of the Friends Life BPO deal.

In July, CEO and managing director N Chandrasekaran was confident that TCS would maintain growth, going forward.

But analysts said despite lower volume growth, TCS revenue growth could still inch up to approximately 4-5% on quarter. But they expect pricing to be stable. Though sequential margins are expected to be down, full-year should hold up, they said.

TCS is also not expected to benefit from rupee depreciation in the quarter, which may further drag down margins.

“TCS has decided to invest the benefits of INR depreciation in pursuing lower-margin strategic deals that may not have met its margin threshold earlier,” said Ankita Somani of Angel Broking.

However, she believes overall stable pricing and a healthy deal pipeline with no project cancellations will help TCS meet its target of growing at a faster rate than Nasscom’s guidance of 11-14% on a constant currency basis.

“TCS has executed well over the past many quarters but valuations are running high at 19.9x and 18.5x this and next fiscal’s EPS of Rs 67.3 and Rs 72.4, respectively. We continue to remain positive on the stock but given the current valuations, we do not see any meaningful absolute upside from the current levels. We maintain our neutral view on the stock,” she said.

A slight change in hedging may also provide some gains to TCS. Abhiram Eleswarapu of BNP Paribas says, “TCS has moderately increased its hedges (currently USD1.8b for FY13) and is covered through most of FY13 with options (with upside potential open beyond USD/INR of ~52.00). The company expects to report a small hedging gain in 2Q at current FX rates versus a INR938m loss in 1Q. However, interest income could be lower q-q, as FY12 and 1QFY13 dividends were paid out in 2Q.”

TCS shares closed 3.2% lower at Rs 1,300.40 on Tuesday.