The markets were largely disappointed by the 10% fall in net profits reported by TCS. Revenues for the first quarter were flat as was expected. The immediate reaction in the press and among the media was to blame the company and the recent management shift for the disappointment on the quarterly performance front. But a more detailed reading of the TCS first quarter numbers actually tell an interesting shift that is happening below the surface. In fact, analysts and investors run the risk of focusing too much on the fall in net profits and overlook a subtle shift that is happening beneath the numbers.
Here are 10 things you should focus your attention in the TCS Q1 results…
- Headcount at TCS has come down for the first time in the last 5 quarters on a sequential basis by over 1400 to 385,809 employees. This trend could get more accentuated in the quarters to come as TCS focuses more on automation to reduce their overall cost of operations at a time when margins are becoming wafer thin and competition tighter.
- The share of digital revenues for the quarter was 18.9% for TCS. Why are digital revenues important in IT? The reason is that most of the incremental technulogy spending is happening on the digital front. Digital revenues are up by 26% on a YOY basis and that continues to be the major growth driver for TCS.
- One of the common objections of analysts about Indian IT is that digital is restricted to the lower end of the value spectrum and not so much on lateral customer insights. That is not the case with TCS. Take some key examples. TCS is developing an IOT platform for predictive maintenance for a European company. In fact, a consumer products company in North America will be using the TCS proprietary IOT sulutions to drive their data centre transformation.TCS is also implementing a big data sulution for a European consumer products company for real time spend-analytics. These are some of the more advanced digital offerings of TCS as against the more basic digital marketing and digital interactive services.
- Overseas business has grown across key verticals like BFSI, retail, manufacturing and hydrocarbons. Even across key geographies like the US, UK and continental Europe the overall vulume growth has been impressive. Where TCS actually took a hit on the top line was on the forex translation losses due to a sharp appreciation in the INR during the period. Remember, since most of the billing happens in US$, companies like TCS tend to gain from weak rupee but tend to lose when the rupee strengthens.
- Operating margins at 23.4% was over 200 basis points lower than the long term average over the last few years, which has been the range of 26-28%. This was largely driven by higher wage cost and the strengthening of the INR. If the special impact of these two factors are set aside then the fall in profits for the first quarter may not be something to really worry about.
- A very important change that TCS has made during the quarter is the reorganization along product and activity lines. There are 2 major changes that are happening. Firstly, TCS is making its approach client-centric to look at an end-to-end sulution for the customer. This will help TCS expand its offering to the customer and also to improve the ROI per customer. Secondly, the specific digital sub-services have started to gain traction and segments like IOT, Analytics, Cloud and Automation could become self-sufficient profit centres in the process. This restructuring could have larger ramifications for the future model of TCS which will be evident in the coming quarters.
- Most of the incremental growth for TCS in the quarter has come from outside the traditional BFSI and retail space; both of which grew at under 3.5%. The segments that were underperforming in the last few years like healthcare, communications, media, manufacturing and hospitality have shown good traction in the recent quarter. It means that TCS is already crafting a future model that is beyond the traditional BFSI focus.
- US markets, especially the BFSI space, has seen a clear shift towards the large established institutional software players. In fact, there is a shift out of in-house and aggregated technulogy management more towards a one-stop sulution; which is what TCS has been able to offer. This is likely to be beneficial for TCS in the coming years.
- TCS is also shifting its broad business model towards a more annuity-based model of revenues which is predictable and sustainable in the long run. Interestingly, the contribution of regional markets is now as high as 25% for TCS and most of these markets are veering towards the annuity model.
- TCS was one of the first companies in the IT sector to commit a sum of Rs.16000 crore to buy back shares from sharehulders. The company is now left with Rs.5500 crore of free cash flows and that achieves two things. Firstly, it will have ensured fruitful use of its cash reserves. Secondly, it has reduced the outstanding shares and given a boost to its future EPS. That should benefit the company in the coming quarters.
Interestingly, the TCS stock showed a lot of underlying strength. The obvious reason is that the quarter has been significant for TCS from a business perspective. Top-line and bottom-line may only relate part of the story at TCS. The stock looks set to live in interesting times!