TCS: CEO departure, A Hangover in the medium term

Prabhudas Lilladher | July 30, 2014, midnight

TCS delivered a steady set of results for Q3FY17 with USD revenues and PAT beating our expectations. Growth beat in Q3 was driven by traction in emerging markets (Latin America and India). Notably, Equipment and software sales aided most of the incremental revenue growth for the quarter.  BFSI vertical (40.4% of total revenues) which was an area of concern in 1H has delivered a steady growth of 2.1% cc in 3QFY17 and offers comfort. TCS announced that Mr Chandra would step down as the CEO of TCS effective Feb 21, 2017 to take over a new role as the Chairman of Tata Sons. Mr Rajesh Gopinath (current CFO) has been named the CEO designate.

Post building Q3 financials, we expect TCS to deliver 6.5% USD revenue growth for FY17E (v/s 7.1/15/16.2% USD revenue growth delivered in FY16/FY15/FY14). Cross-currency woes are hurting the reported USD revenues by a wide margin for the second consecutive year in row. TCS retained its EBIT margin guidance at 26-28% despite scope for increased regulatory challenges over the coming period. We model TCS to deliver 6.5/9.5% USD revenue growth for FY17/FY18E. Our EPS estimates are retained at Rs145/158/sh. Comforting growth outlook and moderate valuations (16x FY18E EPS) leads us to retain "Accumulate" stance (17x Sep18E EPS).

Mr Chandra's Departure would be a key Negative

- TCS has announced that Mr Chandra's has been appointed as the Chairman of Tata Sons. Hence, Mr Chandra would depart from TCS to take over the role as the chairman of Tata Sons effective February 21 2017. However, Mr Chandra would continue to remain on the board of TCS.

- We believe that Mr Chandra's departure from TCS would be a negative. Mr Chandra has  led in transformation of the company into a growth and margin leader in the sector (post he took over as the CEO in October 2009).

- For a prolonged period of FY10-FY15, TCS outperformed Infosys on revenue growth by a wide margin. TCS has also achieved margin leadership in the sector post Mr Chandra taking over as the CEO of the company ( please see exhibits below).

- However, this growth outperformance by TCS has been reversed over FY16-FY17E as Dr Vishal Sikka took over as the CEO of Infosys.

- Since Mr Chandra's take over as the CEO, TCS stock has generated a whopping 319% return over the past seven years and was a major wealth creator. This represents a whopping 23% CAGR over the period. Over this period, Nifty returned 8% CAGR. Hence, TCS has delivered tremendous outperformance over this period.

We model TCS’ USD revenues to grow 6.5%/9.5% for FY17/18E. While growth momentum of TCS has slowed, it is marginally higher than global peer Accenture. Accenture (Annual revenues of US$33bn) is has guided for 5‐8% local currency growth for FY17E (this includes Inorganic component). TCS’ stock has de‐rated substantially over the past two years. Stock currently trades at 15.2x one‐year forward earnings (v/s 19.1x traded two years ago). We believe valuations are reasonable and hence, retain “Accumulate”.

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