Street may be ignoring TCS headwinds as the stock's peak valuation doesn't seem justified by BFSI weakness, likely higher US tax rates and stronger rupee, reports Ram Prasad Sahu.
The market capitalisation of Tata Consultancy Services is close to Rs 6 trillion, the company's stock gaining 46 per cent over its 52-week low of February last year.
Half the gains have come over the past month, a large part after the December quarter results.
The sharp rise means the stock is trading at an expensive valuation of 20 times its estimated FY20 earning.
The near-peak valuation is also a 10 to 14 per cent premium to the target prices of brokerages.
On the other hand, the fundamentals are not so supportive.
Analysts at Kotak Institutional Equities say the stock is trading at this level even after recognition of a potential cyclical uptick.
The stock has already reached the peak cycle multiple, implying annual growth of about 12 per cent for the next seven or eight years.
While the Street's enthusiasm after the December quarter (Q3) results rests on positive commentary on the outlook from both TCS and its peers, a positive trend in deal signings and strong traction in the high-growth digital segment, there are three risks to these valuations.
The first is the weakness in the banking, financial services and insurance (BFSI) division.
In addition to the retail vertical, BFSI has been the other key laggard for Indian IT services in recent quarters.
While the retail business for TCS looks like it is coming out of the woods, given the six per cent sequential uptick in the quarter, BFSI, accounting for over a third of overall revenue, continues to be a problem.
The vertical registered revenue decline of 1.7 per cent over the September quarter.
Analysts at HSBC say as the company was non-committal on the outlook for BFSI, this would mean growth for TCS will remain restricted to 6 to 8 per cent until banking, a third of the business, picks up in earnest.
Some BFSI companies have not finalised their information technology spending budgets and are holding back.
However, a key negative is the trend of in-house implementation of IT projects by some clients.
This captive shift has led to the shrinking of budgets for existing projects and could impact future projects as well.
The other negative is additional burden under the new US tax regime.
Analysts believe there could be a 100-basis point increase in rates resulting from implementation of the Base Erosion and Anti-abuse Tax in the US.
Finally, there is hardening of the rupee versus the dollar, which will impact revenue. Some analysts are factoring in Rs 64 a dollar in their estimates, compared with Rs 65 earlier.
On Thursday (January 25), the rupee closed at 63.545 to a dollar.
Analysts at Credit Suisse believe though TCS' margins have been stable, its FY18 ones are likely to fall short of its targeted range of 26 to 28 per cent, with adverse currency movement a reason.
While strong growth in all verticals in Q3, barring BFSI, is a positive and the 14 per cent sequential revenue growth in digital services (22 per cent of overall revenue) should help, investors should be cautious rather than run with the current momentum.
Photograph: Danish Sidiqui/Reuters