TCS reported an in-line revenue growth of 4% q-o-q CC in Q2FY22. However, USD revenue growth (2.9% q-o-q) missed our estimate of 3.7% q-o-q growth. Ebit margin expanded by 10bp q-o-q to 25.6%, but was lower than our estimate of 26.2%, on supply side challenges. PAT stood at Rs 97 bn, up 6.9% q-o-q, aided by higher other income and stable ETR. The company reported an OCF/PAT of 103% and a FCF/PAT of 97% on good working capital management, indicating the ability to generate strong cash flow. H1FY22 USD Revenue/ Ebit/ PAT grew 19.1%/20.6%/28.4% y-o-y.
Deal wins stable: Deal wins in Q2FY22 stood at $7.6 bn (-6% q-o-q), implying a book-to-bill ratio of 1.2x. TCS saw another quarter of a healthy mix of deals across sizes. Overall TCV was up 25% y-o-y after excluding one mega deal from the Q2FY21 base. Steadiness in deal wins, despite the absence of mega deals, is encouraging for the company.
Demand environment strong: The commentary on the overall demand environment continues to remain upbeat. It sees increased technology intensity from enterprise customers and expects demand momentum to continue in the medium term. Cloud adoption is at initial stages as only 20-30% workloads have moved to the Cloud.
Supply-side challenges: LTM attrition for TCS rose 330bp q-o-q to 11.9%, indicating a clear supply-side crunch in the industry. At the same time, it had a strong net addition of 19,700 employees q-o-q. The management said supply-side challenges will continue to remain high for the next 2-3 quarters before normalising. We expect current supply-side challenges to normalise in medium term.
Margin to remain soft in the near term: H2FY22 is seasonally strong for margins, given the absorption of wage hikes and operating leverage. However, management has indicated that margin in the near term can be soft, led by ongoing supply-side challenges.
Estimates and valuation: We remain positive on the company, given its strong growth outlook. But high valuations leave limited room for disappointment. A miss on estimates in Q2FY22, coupled with a soft margin outlook, can result in near term pressure on the stock. We have reduced our EPS estimates by 2%/4% for FY22E/FY23E. We expect 14.3%/18.4% USD revenue/EPS CAGR over FY21-23E. Our TP of Rs 3,770 per share, implies 31x FY23E EPS. We maintain our Neutral rating.