TCS Upgraded To 'Buy' By UBS On Revenue Growth, Margin Improvement Outlook

Multiple levers to outperform its peers in terms of revenue growth and margin improvement have driven UBS Securities India Pvt. to upgrade Tata Consultancy Services Ltd.

The brokerage upgraded the stock's rating to 'buy' from 'neutral' and raised the target price to Rs 4,700 from Rs 4,050, implying a potential upside of 17.5%.

"We believe the market is not completely taking into account the impact of the large deal ramp-up and scope of margin improvement through utilisation, pyramid restructuring," it said in a note dated Feb. 26. "We believe the market could be positively surprised by margin expansion in the coming quarters."

UBS said it is very likely that the company will positively surprise on revenue growth expectations in the next financial year.

The growth levers that are likely to favour TCS include the ramp-up of large deals won in the current fiscal so far, potential recovery in the BFSI segment as indicated by management and corroborated by global banks' commentary, according to UBS.

Other levers are increasing market share in BFSI through vendor consolidation, and a potential return of cloud migration projects and increased IT spending in the managed services space, it said. "We think the potential demand recovery in FY25 will positively surprise the market which it is not currently priced in."

The brokerage said the deal with Bharat Sanchar Nigam Ltd. for TCS should add 2.5% to its revenue growth in the next fiscal. However, it will impact margin by 20–30 basis points due to the low-margin BSNL deal.

"The advanced purchase order for the initial 100,000 sites has been rolled out, while the purchase orders for the remaining sites will be issued once the TCS-­led 4G consortium meets key milestones and circle-specific requirements," it said. "We believe TCS completed around 2,000 sites in Q3 along with other services, which contributed $90m revenue from this deal."

"This is in addition to the 5.5% core revenue growth we expect for the company in FY25," the brokerage said.

The brokerage said that efforts in pyramid rationalisation by the company would play a key role in margin improvement. "This pyramid correction should ideally reduce the cost per employee gradually while revenue per employee catches up leading to operating efficiencies," it said.

UBS expects TCS to expand EBIT margin by 150 bps by fiscal 2026 and this will partly be aided by rupee depreciation. "We believe the market is not pricing in margin expansion on a sustainable basis. Any improvement in margins beyond the current quarter will be taken positively by the market, in our view," it said.

On the downside, cuts in clients' IT spends, the reprioritising of key projects in the next fiscal and continued delay of large deal ramp-ups might result in low growth.