Financial Fortitude: Analyzing the Credit Profile and Ratings of Tata Consultancy Services

Fig. Credit Profile of TCS

Moody's Investors Service has affirmed Baa1 ratings for information technology stalwarts, Tata Consultancy Services (TCS)

Kaustubh Chaubal, Senior Vice President, Moody’s, noted that a solid balance sheet characterized by high liquidity and net cash position reflects the companies’ “good corporate governance practices.”

The reason the ratings of the company is constrained to just two points above that of India (Baa3) is their exposure to the changing tax regulations in the country. Nonetheless, diverse operations, a history of strong operating results and profitability, remarkable free cash flow generating capabilities and minimal dependence on the Indian banking system helped Infosys and TCS remain at Baa1 rating.

Moody's expects TCS’ revenues to clinch 8 percent growth for the fiscal year 2023, but water down to around 5 percent for the fiscal years 2024 and 2025.

Coming to profitability, TCS’ EBITDA margin is expected to stay around 25 percent during the down years, supported by steadily declining attrition and improving employee utilisation.

TCS’ largely unleveraged balance sheet and superior liquidity position should help the company return 80 percent to 100 percent of its free cash flow to shareholders.

Credit ratings agency Standard & Poor's (S&P), has said that it has affirmed Tata Consultancy Services Ltd’s long-term corporate credit rating to ‘BBB’ and revised the company’s outlook to ‘positive’ from ‘stable’.

S&P said that it expects the company's revenue, which was steady during the downturn, to register moderate growth, going forward. “Growth will be fuelled by the global economic revival and our expectation that India-based IT service providers will continue to benefit from higher outsourcing," said Suzanne Smith, S&P's credit analyst and managing director, corporate and government ratings, for South and Southeast Asia.

Fitch Ratings - Hong Kong - 29 Nov 2023: Fitch Ratings has affirmed India-based IT service company Tata Consultancy Services Limited's (TCS) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'A'. The Outlook is Stable

The affirmation reflects Fitch's expectation that TCS will maintain its solid global market position, technology leadership in key industry verticals, diversified operations, robust and resilient profitability, strong operating cash flow generation and highly conservative capital structure with a large net cash position.

KEY RATING DRIVERS

Strong SCP: TCS's SCP is underpinned by its position as the world's third-largest IT service provider by revenue. It has a strong global presence and deep expertise in multiple industry verticals, and differentiates itself in industry knowledge and understanding of business processes, timely investments in new capabilities and reskilling its workforce, a large portfolio of products and platforms, and its customer-centred strategy. We expect the company to continue to strengthen its market position, with a rising share of customer spending and services provided.

Limited Parental Influence: We do not believe TSOL will take actions that weaken TCS's SCP. Both TSOL and TCS have strong corporate governance. TSOL does not control TCS's board and there is a long record of maintaining a conservative balance sheet at TCS. TCS only pays shareholder returns from generated cash flow. TSOL has no operations of its own and TCS manages its funding and operations independently of TSOL. There are no inter-company loans and limited related-party transactions.

Slower Near-Term Growth: TCS's credit profile should remain solid, despite slower near-term growth. We expect slower revenue growth to continue in the next few quarters, as TCS's customers are turning cautious amid global uncertainties, and are reprioritising and cutting discretionary spending, which also affects the wider Indian IT sector. However, TCS has so far outperformed most local and global peers in growth and profitability. On a constant currency basis, TCS's revenue growth slowed to 2.8% yoy in the second quarter of the financial year ended March 2024 (2QFY24) from 7% in 1QFY24.

Long-Term Growth Remaining Intact: We believe the near-term challenges are unlikely to alter the long-term growth potential of the Indian IT service market, which is underpinned by secular demand drivers, such as digital transformation, data growth and transition of IT systems to the cloud and AI technologies. We expect customers to increase IT spending over the longer term to drive operational efficiencies and make use of technology for competitive differentiation.

Robust and Resilient Profitability: We forecast TCS's EBITDA margins to stay stable at 25%-26% in next few years, as weakening demand offsets easing wage pressure. TCS's IT staff attrition rate fell to below 15% in 2QFY24, from the peak of 21.5% a year ago. In addition, TCS is focusing on cost management to increase utilisation and reduce the use of sub-contractors in order to defend margins amid slower revenue growth.

Highly Conservative Capital Structure: We expect TCS to maintain a large net cash position despite its generous shareholder return policy. We expect TCS's pre-dividend free cash flow (FCF) margin to remain high at around 18% in the next few years, which will support its investor-friendly cash-return policy, while maintaining a net cash position. TCS will continue to return most of its pre-dividend FCF to shareholders via regular and special dividends and share repurchases. The company has no plan to raise domestic or foreign debt.

No Country Ceiling Constraint: The Foreign-Currency IDR is equal to the Local-Currency IDR, as we assess the applicable Country Ceiling for TCS to be 'AAA'. We believe profit from TSC's overseas subsidiaries in countries with Country Ceilings of 'AAA' is sufficient to support a reasonable amount of foreign-currency debt, even though the company has no intention of raising such debt.

Relative Valuation among peers

Fig. TCS relative comparative valuation

• Revenue: TCS accounts for 100% of the segment revenue.
• P/E Ratio:
• Compared to IT Services peers, TCS has a P/E ratio of 27.0x, while the average for its peers is 20.3x. This means that TCS stock is more expensive than its peers relative to its earnings.
• Compared to the whole firm composites, TCS has a P/E ratio that is a premium of 26.7x. This suggests that investors expect TCS to outperform the broader market.
• EBITDA: TCS's EBITDA margin is 76.03%, which is higher than the median for its peers (41.40%). This indicates that TCS is efficient at generating profits from its operations.
• Debt: TCS has a debt-to-equity ratio of 0.13, which is lower than the median for its peers (0.42). This means that TCS has a relatively low level of debt compared to its equity.