There is always something admirable if you can take a ‘miss’ with the same grace and honesty as you would for a ‘hit’. The Tata Consultancy Services (TCS) management saw a modest Q2 with growth rates seeing a slowdown and margins being under pressure. While there were a number of reasons for this, macro-economic worries leading to clients delaying decision making across North America, banking and finance services and retail, delay in ramp-downs of deals and currency volatility, to name a few; the management did not try to mask the pressure points but at the same time maintained their positive view on the core structure of their business.
The second quarter unavoidably caught the company by surprise, but as Rajesh Gopinathan says and his predecessor N Chandrasekaran always maintained, the play for TCS has always been and will be the long-term view. Having covered TCS for over a decade now and seen two key management changes and several economic headwinds, I can safely say the management presented the most strongest front taking tough questions on the chin. The view of the management seems to be clear. While quarterly blips directly lead to stock fluctuations and are important; the structural strength of the company depends on the long term view, which continues to remain positive albeit in immediate need of levers to weather the current transitory storm that may stay for the immediate two quarters, at least.
Speaking to CNBC TV18, the management, in one of their most candid quarterly interviews, shared some important points discussed by them that help put some perspective on the road forward.
Margin target of 26-28 percent — Achievable in one-year time
With margins coming in at a decline of 20 bps, alarm bells have been raised on how TCS will scale margins in a time of tough growth. The last time margins saw a decline in Q2 was FY13 and prior to that FY05. In FY16, TCS shared its aspirational margin target band of 26-28 percent. At that point the management was well on its way to meet the lower end of the target range. But with currency fluctuations as well as macro-economic volatility, the situation changed. For Q2FY20, the company posted margins at 24 percent down 20 basis points from the previews quarter. V Ramakrishnan, fondly called Ramki, usually stays away from giving a timeline for this target. But speaking to us, he outlined that the company should be able to reach that target in a years’ time. In inference, by Q2FY21, the 26 percent target would be achievable.
Focus of the company is to get back to double-digit growth
Typically, the first two quarters of the fiscal are seasonally strong quarters. The second quarter is critical to determine which was the growth will progress. As the company started the fiscal, in April, the view was that FY20 will be better than FY19, which saw a growth of 11.5 percent yoy. As the year progressed, in July, it seemed that FY20 growth rates will be in line with FY19. But post the second quarter numbers, with the company posting constant revenue growth of 8.4 yoy and 1.6 percent qoq, it's evident that a double digit growth may be unlikely and the company will probably remain in high single digits. Nevertheless, Rajesh Gopinathan and the team have their eyes focussed on the ball and will defend the current growth trend. "We are not giving up by any state of imagination. H2 is around 9.5, we are going to defend it. Let us see what we can do," he says.
While BFSI and retail aren't showing clear signs of growth yet, the management says that it is focussed on bringing BFSI and retail back to double-digit growth. With clients in BFS, specially the large banks in Europe and North America, taking longer than expected in decision making, visibility on when BFS will see a turnaround is still unclear. In the case of retail, the third quarter will be critical in defining the pipeline and outlook going forward. But as Rajesh Gopinathan puts it, it is not about the retail of BFS story anymore. He says the demand is broad-based and hence the company is bullish that the verticles with lesser exposure will scale up to drive and accelerate growth... again in the long term.
Till date, TCS has returned about Rs 22,000 crore plus to shareholders. In keeping with this strategy on capital return policy with shareholders, TCS has announced a special dividend of RS 40/ share, which leads to Rs 15,000 crore of payout. When asked if a buyback is unlikely now, V Ramakrishnan said that it was ultimately the board’s decision but at this point, given the tax rates, dividend is the preferred route and makes more economically rational sense
Prefer dividend to buyback; more economically rational
instead of buyback
Digital growth slowdown to abate soon in the coming quarters
Digital growth for the quarter, at 33.2 percent of the overall revenue, came in at 27.9 percent. This is a steep fall from the 42.1 percent growth it clocked in the last quarter with 32.2 percent of overall revenue contribution. The company's COO N Ganapathy Subramaniam, fondly known as NGS, said that digital will get back to the earlier growth rates in the coming quarters. While digital has seen an impact of the slowdown in pockets, it is still more resilient than the traditional business, albiet not unaffected
Benefits of pyramid rationalising to start kicking in from next quarter
A significant portion of the cost increase this quarter was in hiring. The company hired 14,097 employees in the quarter, highest quarterly addition. Add to the increase in bench costs, subcontracting costs, investment in skilling, higher onsite costs led to a heady cocktail of increased expenses. The management has a clear tactical plan to optimise cost and reduce the pressure. Milind Lakkad, the global HR head of the company, explains how it is working on a pyramid rationalisation of employee structure. This effectively will help bring down costs. The company for this quarter adopted a front-end approach to hiring which led to numbers getting impacted by 50 bps, explained Milind. The goal is to bring down subcontracting costs, which according to Ramki, are already at a downward trend. All in all, the plan for pyramid rationalisation is especially to start kicking in from next quarterWhat's evident is that while the company is confident about the pipeline, there are clear points of volatility to circumvent, and the company is not in denial about the steps it needs to take to accelerate growth.