Worse than expected performance puts TCS on a slippery margin path

Information technology (IT) services giant Tata Consultancy Services has performed worse than analyst expectations, with a 6% decline in revenue in constant currency during the first quarter ended June of the financial year 2020-21. 

On Thursday, TCS reported a 13.8% decrease in quarterly profit in the first quarter of FY 2020-21 as the Covid-19 pandemic eroded revenue across verticals. To put the company performance in perspective, the revenue decline of 7.1% quarter-on-quarter and by 7.8% year-on-year, is higher than the revenue decline witnessed during the global financial crisis of 2008.

The company's profits fell by 21% in dollar terms, while the fall in rupee terms was only 14%. The margin drop occurred despite a decline in headcount in Q4 FY 20, rupee depreciation and a halt on promotions and increments. The 20% growth in total deal wins came at a much lower rate than what the Mumbai-based company usually sees, said analysts TechCircle spoke with.

"With continued uncertainty in the United States market, the upcoming elections and visa issues will dampen growth momentum that is expected in the second half of the year. While the deal pipeline looks good, conversions and pricing seem to be a challenge. The most important verticals such as banking, financial services and insurance (BFSI) and retail is getting worse and no reasonable uptick seen in the next couple of quarters," V Balakrishnan, former Infosys CFO and founding partner of venture capital firm Exfinity Ventures, told TechCircle

The financial services vertical contributes to more than 35% of revenues for most Indian IT services majors. Geographically, the North American market contributes to around 50-60% of revenue for most firms. Retail, which contributes another 15% of revenues for IT firms overall, declined by 13% for TCS during the quarter. 

The company recorded modest growth in revenue from Europe at 3% despite the pandemic hitting the continent severely in March and April. The growth was mostly through market share gains.

The country's largest software exporter also saw deal wins amounting to $6.9 billion, which is 20% higher than the same quarter of last year. It also added four new $100 million clients during this tough quarter.

The second quarter is traditionally the strongest period for IT firms, meaning that if the customers face headwinds during the period, the deal wins might not convert into revenue

"Conversion depends on the environment. If there are too much of uncertainties customers will postpone the deployment. Pricing is a challenge in all new projects that the companies sign. Customers do ask and get discounts when things are bad. This will be more visible in the margins," Balakrishnan said. 

Rupee appreciating in the current quarter could cause also create trouble for IT services firms.

TCS' 40% exposure to the BFSI sector means that its challenge will continue for the next two to three quarters, according to DD Mishra, analyst and senior research director at Gartner. 

“Since most other sectors are also not performing well, the decline in revenue was expected. We can expect recovery from 2021, if things improve from here onwards," he added.

TCS has pinned its hopes on the surge in demand for digital infrastructure solutions.

"TCS would benefit from three broad spending themes of customers switching to remote model, front-end customer experience transformation and the expected recovery of BFSI vertical in the Q2, given the stimulus by the governments in key markets as well as the higher spending around fund distribution," brokerage firm Sharekhan said in an analyst report on TCS.

An increase in offshoring work is also expected to help Indian IT firms at a time the US government has put curbs on new work visas, according to Gartner. "We are seeing huge interest in offshoring as a means of cost reduction and vendor consolidation. Many large customers are taking to these options to counter the shrinking budgets," Mishra said.

Meanwhile, other large IT services firms such as Infosys, Wipro, HCL Technologies and Mindtree are expected to announce their results next week. If earnings at TCS are any indication, other firms could post even worse results.

"TCS was supposed to be better off than others. Overall this indicates most service providers will show annual revenue decline in single digit 4-8%. This quarter revenue on a quarter-on-quarter basis will see a 5-15% for most service providers," Pareekh Jain, founder of Bengaluru-based technology consulting firm Pareekh consulting said.

Jain added that the year-on-year growth comparisons are not a good metric to follow this year for understanding the economic and demand recovery paths of companies. "The Q2 or Q3 results should definitely see growth in comparison to Q1," he said.