TCS shares underperform Nifty for fourth year in a row

Mumbai: Shares of Tata Consultancy Services Ltd (TCS), India’s largest IT firm by market value, underperformed benchmark Nifty50 index for the fourth consecutive year in 2017. So far this year, TCS has gained 12.49% compared to a 26.1% rise of the 50-share index, according to data from Bloomberg.

Despite the underperformance, TCS shares are still the most expensive in the IT space. According to Bloomberg data, TCS is currently trading at a price-to-earnings (PE) ratio of 18.07 times, based on FY19 earnings, over 4% lower than its five-year average PE ratio of 18.89 times.

Brokerage firm Nomura Research finds valuations of TCS to be expensive as it is not convinced on margin sustainability and expects earnings before interest and tax margins to fall to 23.9% in fiscal year 2020 forecast from 25.7% in fiscal year 2017.

TCS has been under constant pressure with earnings falling below analysts’ estimates. Challenges like weak performance in the US and soft demand from clients in the banking, financial services and insurance space have eroded its business. According to analysts, BFSI (banking, financial services and insurance) deceleration of TCS was led by certain US clients, where relaxation in regulations not playing out led to pushback in planned initiatives.

“Given the concentration of revenues in banking, financial services and insurance (BFSI) and retail (57% of revenue), overall growth was impacted in retail, this was driven by a set of clients where there were cost-cutting pressures (store closures, staff cost and other cost-cutting initiatives), which impacted demand,” said Nomura Research in a 1 December note.

It said that slowing growth in the US, weak legacy segment growth dragging down strong digital growth over the last 12 months as the legacy segment is 80% of revenues, and competition from Accenture are the main challenges for TCS.

Of the 52 brokers tracking the TCS stock on Bloomberg, 10 gave a “buy” rating as against 41 “buy” ratings in October 2014 when the stock touched a record high. Analyst at 12 firms asked its investors to “sell” the stock and 29 have a “hold” rating as compared with 3 and 15, respectively, in the same period.

TCS, along with India’s IT space, has been facing headwinds as a result of protectionist policies proposed by the US. A legislation introduced in the US proposed, among other things, a 100% pay hike for H-1B visa holders—this would automatically restrict firms from hiring low-wage workers in the US and instead hire American workers.

That along with the wider adoption of artificial intelligence, automation and cloud computing has resulted in anaemic growth and declining profitability for the industry at large, prompting companies to cut down on workforce. India’s $150 billion IT sector was regarded as one of the biggest job creators in the organised sector.

A similar shift in analysts’ recommendations stands true for the overall IT space. Barring Wipro Ltd, valuations of large IT companies have corrected from its five-year average price earnings of 14.93 times down to 14.3 times.

“The sector is undergoing a phase of consolidation in the business model owing to digitalisation, artificial intelligence and cloud computing. Continuous downgrade by the large caps on their revenue guidelines is putting pressure on the outlook. The management has indicated that headwinds in the BFSI verticals have bottomed out and visibility in the spending plans will be available by the end of Q3FY18 which we believe is reasonable on long term valuation basis,” said Saji John, IT analyst at Geojit Financial Services.

Analysts expect IT spending in India to slowdown. Spending will grow at 9% to $87.1 billion in 2018 as compared with a 14.2% growth seen over the previous year in 2017 at $79.8 billion.