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TCS’s low-growth, high-valuation combination smells like trouble

LiveMint logoLiveMint 05-09-2017 Mobis Philipose

Infosys Ltd’s pain hasn’t exactly been Tata Consultancy Services Ltd’s (TCS’s) gain.

While Infosys shares have fallen as much as 12% since its leadership crisis came to the fore, this hasn’t led to any increase in allocations to TCS.

The industry leader’s shares have more or less tracked the performance of the broad market and peers since the crisis at Infosys.

TCS shares have declined 1.1% since 18 August, while the Nifty index has been flat in the same period.

One of the reasons all the selling in Infosys shares hasn’t resulted in considerable increases in allocation to TCS is simply that investors—primarily foreign investors— were already overweight on the industry leader.

Besides, TCS’s valuations are already way ahead of peers and considerably higher than what its growth rates warrant.

“We build in USD revenue/EPS CAGR of 7%/3%... and find valuations of 19.1 times estimated FY18 earnings expensive,” analysts at Nomura Research point out in a note to clients. The single-digit growth projection is for the two years between FY17 and FY19. EPS is earnings per share and CAGR is compound annual growth rate.

TCS’s commentary on the key banking and financial services, and retail and consumer packaged goods verticals continues to be downbeat. Nomura’s analysts point out that these segments account for as much as 57% of the company’s revenues.

The weakness in demand was also reflected in a weak start to the year—TCS reported sequential revenue growth of just 2% in the seasonally strong June quarter, and, worse still, its margins fell by 240 basis points. Its growth has been slowing almost every passing quarter.

Besides, while demand for digital services is robust, these account for only about a fifth of the company’s business. The rest comes from traditional services, where demand is flagging.

Of course, unlike Infosys, TCS has had a smooth leadership transition, and isn’t plagued by concerns about corporate governance, which has helped draw foreign investors to the counter. But at 19 times forward price-earnings ratio, the company’s shares have priced in all this and more. In fact, given the weak growth outlook, investors may well be setting themselves up for trouble.

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