TCS Earnings: Miss as Discretionary Consulting Spending Remains Conservative; Shares Overvalued

Wide-moat Tata Consulting Services’ TCS second-quarter results missed our top- and bottom-line expectations as customers remained conservative on spending amid macroeconomic uncertainty, which we believe will persist over the next few quarters. We are maintaining our INR 2,960 fair value estimate. The shares saw little movement after results, leaving the IT services giant trading in overvalued territory, in our view. Nonetheless, we believe TCS is a high-quality firm with a trio of resilient moat sources.

Revenue of INR 597 billion increased 3% year over year in constant currency. Tata’s energy, resources, and utilities vertical business was a standout, growing 15% year over year in constant currency, but three verticals saw declines, with technology and services experiencing the worst as revenue fell 2% year over year in constant currency. On a brighter note, IT services attrition stood at 14.9% over the last 12 months, a nice change from 21.5% as of the 12 months ended in the prior-year period. Additionally, profitability has pushed ahead through productivity and cost-efficiency improvements, bringing operating margin to 24.3% compared with 24% in the prior-year period.

TCS does not give a financial outlook for the quarter or year ahead, but we continue to believe the market is overvaluing the company’s growth and profitability potential over the next few years. The boom in interest in higher-level artificial intelligence capabilities, like generative AI, does hold nice potential for the firm. However, we believe such related consulting projects will be more moderate than the market’s estimates, as talent in the industry is not unlimited; there’s only so much supply at a given time to meet outsize demand once customers open their wallets. While TCS has done a great job of adopting technologies to reduce dependency on head count, this move is a gradual one.