Only a fifth of all analysts tracking TCS have a buy rating, and even they had an average target price of around Rs3,020. TCS shares now trade at Rs3,176 apiece
Tata Consultancy Services Ltd’s (TCS’s) shares are in a tearing hurry. So far this year, the company’s market capitalization has risen 18% to Rs6.1 trillion ($95.6 billion). It is fast closing in on Accenture Plc, which has a valuation of $103 billion.
In the process, TCS has raced past the target price set by analysts who are most bullish on the company’s prospects. Only a fifth of all analysts tracking the stock have a buy rating, and even they had an average target price of around Rs3,020. TCS shares now trade at Rs3,176 apiece.
In other words, TCS’s valuation is now far ahead of what its most ardent supporters think it should be. True, one broking firm, UBS, has set a target price of Rs3,650 for the stock, although it is an outlier. TCS shares are ahead of all other target prices set by broking analysts.
According to an analyst at a multinational brokerage, TCS shares are reaching levels where the number of sell ratings on the stock is bound to increase. Currently, about a fifth of all ratings are sell or reduce, while the majority (around 55%) of broking firms have a hold or neutral rating on the stock. This is predominantly because of the company’s high valuation; and not so much a reflection of growth prospects vis-a-vis peers.
In a note to clients, analysts at Kotak Institutional Equities have explained what the company’s current valuations mean in terms of growth expectations: “TCS is trading at a peak cycle multiple of 21 times one-year forward earnings, implying 12-13% revenue growth for seven years at stable profitability... While TCS can deliver low-teen growth for a year or two, extrapolating it for seven years would be a bit of stretch.”
Note also that growth in the current fiscal is estimated at less than 7%. As such, growth of 12% over FY18 revenues translates into incremental revenues of $2.3 billion for TCS. Kotak analysts provide a reality check, “It is interesting to note that Accenture has added absolute organic revenues in the range of $1.6-2.5 billion/year at the peak of its sweet spot (during FY2016-18E, which was marked with revival in consulting + shift of spends towards digital).” Accenture operates at a far larger revenue base, and expecting TCS to catch up in terms of incremental revenues will require a reversal of sorts in market share trends.
Besides, as pointed out in this column, growth acceleration in some segments such as the Americas in the second half of last year hasn’t yet translated into higher growth for Indian IT. So expectations of far higher growth in fiscal 2018-19 are riding on hope.
According to an analyst at a domestic institutional brokerage, while things are looking up compared to the previous year, it’s difficult to call out the extent of improvement, since Indian IT companies are also simultaneously losing business/revenues for a number of reasons. For instance, there is pricing pressure in traditional services, besides which IT spend continues to shift from traditional to digital services. Then, there’s the aspect of consolidation of vendors, because of which it’s difficult to predict the winners and losers at the end of the day.
TCS’s bloated valuations suggest all these concerns are being blown to the wayside, which is something investors should be worried about.