TCS signals pain in US markets, says banking sector crisis led to discretionary spending cuts

• TCS missed street expectations in terms of profitability and margins in Q4 amid a deteriorating macroeconomic environment.
• The IT major signaled pain in the US market, noting that the crisis in the banking sector has impacted and in some cases halted customer discretionary spending.
• While the company acknowledged that this pain could continue in the short term, it declined to provide guidance due to uncertainty.
• However, it remained bullish on the medium and long term, citing a healthy order book.

Indian IT bellwether Tata Consultancy Services (TCS) was cautious and concerned about the US, its largest market, after publishing its fourth-quarter results. The US banking crisis has led customers to cut discretionary spending or even to halt non-critical projects, it added.

The company on Wednesday reported its slowest constant-currency revenue growth in 11 quarters and declined to provide guidance due to economic uncertainties. The outgoing chief executive officer (CEO) Rajesh Gopinathan accepted that the numbers were “definitely weaker than expected”.

“Last quarter, we expected North America to recover meaningfully by the start of the year. This recovery has clearly failed to materialize and turned out to be more negative than we expected,” said Gopinathan.

In a post-earnings conference call with analysts, Gopinathan was cautious, pointing out that near-term visibility remains limited due to mounting economic uncertainties. Despite this, the company remained confident in its medium and long-term capabilities.

“Customer sentiment in the BFSI (banking, financial services and insurance), retail and technology services, particularly in Europe and the US, has been one of caution,” said Gopinathan. The BFSI vertical is by far the largest for TCS – it contributed more than half of the company’s total net profit in FY23.

TCS missed street estimates in terms of earnings which came in at ₹11,392 crore for the March quarter, lower than the expected ₹11,550 crore. The operating margin was also sequentially flat at 24.5% in the fourth quarter, while analysts had estimated an improvement of 40-70 bps.

In response to the company’s results, shares of TCS fell nearly 2% in trading on Thursday. In 2023, shares are down 2.2% year to date.

The crisis in the banking sector is forcing customers to rethink their spending

While TCS’s banking industry clients remained steadfast in their relationship with the company, the spillover of the banking crisis with the collapse of five banks in the US and Europe in March was visible among other clients, who eventually cut their discretionary spending, he said. Gopinathan. .

“Customers were delaying newer initiatives that weren’t critical. In some cases, [they] completely halted discretionary projects,” Gopinathan said.

There was also economic uncertainty about the performance of Big Tech in the US. Apple, the world’s largest publicly traded company, fell short of earnings expectations in the December quarter due to lower iPhone sales and supply chain disruptions in China due to the country’s strict zero-Covid policy.

Google parent Alphabet said its advertising partners could cut back, while e-commerce giant Amazon forecasts lower demand.

Overall, the tech-heavy Nasdaq is down more than 12% over the past year. Apple’s shares are down more than 6% during this period, while Alphabet has lost nearly 20% of its value. Amazon lost the most, with a fall of more than 37%.

Krithi Krithivasan, CEO candidate of Gopinathan and TCS, noted that there has been weakness in all sectors in the US due to economic uncertainty and that this could continue in the near term. Krithivasan said, “we feel comfortable in the medium to long term.”

Analysts remain optimistic

While TCS was cautious, analysts maintained their optimism about the company’s prospects, noting that customer cutbacks could be just a knee-jerk reaction, especially in light of TCS’s strong demand pipeline.

“Discretionary cuts in the fourth quarter were more of a knee-jerk reaction by customers in response to the risk of bank contagion than a deterioration in the demand environment,” said JM Financial, adding that growth could recover once sentiment improves.

In terms of the order book, Q4 was strong for TCS with a total contract value of $10 billion. The company claimed that deal speed and pipeline were both strong and customers were not skimping on more critical projects such as IT transformation and technology adoption.

Despite the worsening macros, analysts at Motilal Oswal also remained generally bullish on TCS, stating that a slowdown had been partially factored into their estimates. Krithivasan also underlined that the revenue cycle could accelerate in FY24 due to an expected reduction in the share of mega deals, which usually come with a longer gestation period, and a parallel increase in smaller deals.

With the International Monetary Fund lowering the outlook for global economic growth to 2.8% in 2023, it remains to be seen how long it will take for sentiment to improve. For now, TCS and its new CEO Krithivasan are counting on the company’s strong order book, but the company says it will “adapt to customer needs”.

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