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Tata Consultancy Services Ltd (TCS), a leading IT firm in India, reported subdued performance in its September quarter (Q2FY25) earnings, raising concerns about the sector's outlook. The company's sequential constant currency revenue growth of 1.1% fell short of analysts' expectations of 1.3%, indicating a slower pace of expansion than the previous quarter. This weak growth was attributed to several factors, including a decline in the North American market and client issues in the Life Sciences vertical and a UK account.
While the management highlighted signs of recovery in the BFSI (banking, financial services, and insurance) sector, client caution on discretionary spending remained a significant challenge, leading to muted demand for these services. Clients continue to prioritize cost transformation programs, reflecting a trend of conservative spending in the face of global macroeconomic uncertainty and geopolitical tensions. This suggests a gradual revenue recovery in the coming quarters, but the pace is likely to be moderate.
Despite the subdued revenue growth, TCS's deal pipeline remained robust, reaching near record-high levels. However, the market volatility observed in Q1FY25 has persisted, resulting in prolonged deal closure times. This delay in converting deals into revenue growth is a major concern for IT investors. Although the total contract value (TCV) of deal wins in Q2FY25 reached $8.6 billion, a decline of 24% year-on-year, it stayed within the company's comfortable range of $7-9 billion. The ability to strike mega deals in the second half of FY25 will be crucial for TCS to maintain momentum.
However, a more significant disappointment was the decline in the company's earnings before interest and tax (Ebit) margin, which fell by 60 basis points sequentially to 24.1%, significantly lower than the consensus estimate of 24.9%. This margin miss was attributed to higher third-party expenses and subcontracting costs, partially offset by currency tailwinds. This development has raised concerns about TCS's ability to reach its aspirational margin band of 26-28% in the near future.
The disappointing earnings and a less-than-optimistic outlook led to downgrades of TCS's earnings estimates by several analysts. Nomura Global Markets Research pointed out that the BSNL project, while expected to be a revenue driver in the second half of FY25, will hinder TCS from achieving its desired margin targets. Similarly, analysts at Prabhudas Lilladher trimmed their earnings estimates for TCS for FY25 and FY26 based on the significant margin miss in Q2. These downgrades reflect the market's growing skepticism about TCS's near-term prospects.
The market reacted negatively to the Q2FY25 results, with TCS's stock falling 1% intraday on the National Stock Exchange on Friday. While the stock has outperformed the Nifty IT index in 2024, fetching returns of 11%, its valuations have moderated from recent peaks. Concerns remain about a further decline in valuations due to subdued earnings growth. At FY26 price-to-earnings, the stock trades at a multiple of 27 times, according to ICICI Securities.
Overall, TCS's Q2FY25 earnings report painted a mixed picture, highlighting both challenges and opportunities for the company. The softer-than-expected revenue growth and margin miss have raised concerns about the company's near-term prospects. However, the robust deal pipeline and ongoing efforts to optimize costs offer some hope for a gradual recovery in the future. The ability to successfully navigate the current market volatility and convert deals into revenue will be crucial for TCS to achieve its growth aspirations.