Fitch Upgrades Tata Consultancy Services to A, Outlook Stable

Fitch Ratings - Hong Kong: Fitch Ratings has upgraded the Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) on India-based IT service company, Tata Consultancy Services Limited (TCS) to 'A' from 'A-'. The Outlook is Stable.

The upgrade reflects Fitch's reassessment of the linkages between TCS and Tata Sons Private Limited (TSOL), which holds 72% of TCS, based on Fitch's updated Parent and Subsidiary Linkage (PSL) Rating Criteria. We now rate TCS at the same level as its Standalone Credit Profile (SCP) of 'a' as set out in the criteria for a stronger investee of an investment holding company (IHC) such as TSOL, where we believe that the IHC will not weaken the credit quality of the investee by taking out cash or other assets.

While TSOL has the majority of votes at TCS' general meetings, we do not believe it will take action that would lead to a lower SCP for TCS because: corporate governance is strong; TSOL does not control the TCS board; there is a strong track record of maintenance of a conservative balance sheet at TCS, which only pays shareholder returns out of cash flow generated; and, most notably, TCS has a lot of headroom in its 'a' SCP.


Strong SCP: TCS' SCP of 'a' is underpinned by the company's strong global market position, technology leadership in key industry verticals, buoyant industry growth, robust profitability and operating cash generation, and highly conservative capital structure. It is the world's third-largest IT service provider by revenue, with strong domain expertise. It has continuously invested in new capabilities, products and platforms to stay ahead of technology developments. We expect the company to continue to strengthen its position with rising share of customer spending.

Limited Parental Influence on Dividends: TSOL is an IHC with no operations of its own. TSOL does not have strong influence on TCS' board of directors and funding is managed independently. There are no inter-company loans and very limited related-party transactions. TCS has no operational overlap with TSOL and operates independently and is managed by professionals.

We believe that the group's strong corporate governance practices and presence of institutional minority shareholders at TCS will prevent any cash upstreaming to TSOL in excess of its shareholder return policies. To date, TCS has maintained a consistent policy of distributing 80%-100% of reported free cash flow (FCF) (similar to Fitch-defined pre-dividend FCF) as shareholder returns, regardless of TSOL's financial needs. Notwithstanding this, TCS has a large headroom for additional gearing in its SCP, should our expectations for shareholder returns be exceeded.

Solid Long-term Growth Potential: Fitch believes the global IT industry has solid long-term growth potential, and the revenue for rated global IT service companies will expand by around 10% per year in the financial year ending March 2022 (FY22) and FY23. Growth will be driven by higher demand for cloud, cybersecurity and application services as customers continue to upgrade digital offerings as the business environment evolves.

Most global IT service companies, including TCS, have rebounded sharply following temporary disruption in 1HFY21 when revenue growth was affected by an economic slowdown induced by the Covid-19 pandemic. TCS' revenue grew by 18% yoy in 1HFY22, as business customers accelerated their digital transformation plans.

Robust Profitability and Cash Generation: TCS has strong profitability and solid operating cash generation. TCS has the highest margins among global peers. It benefits from pricing power, the high costs to customers of switching vendors, as well as the high degree of integration and flexibility offered by its location-independent agile delivery model. Its staff attrition rates are below the industry average while it has tight cost controls. These should help TCS counter price pressure and mitigate cost increases from wage hikes. We expect EBITDA margin to remain stable at 26%-27% in the next few years.

Highly Conservative Capital Structure: We expect TCS to maintain a large net cash position and for pre-dividend FCF margin to remain high at around 20%. 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 TCS' profits from its overseas subsidiaries in countries with Country Ceilings of 'AAA' are sufficient to support a reasonable amount of foreign-currency debt, even though the company has no intention of raising such debt.


Accenture plc's (A+/Stable) business risk profile is a notch stronger than TCS' SCP as it has a larger operating scale and a stronger franchise in the consulting business. Accenture's financial risk profile is similar to that of TCS. Accenture is more acquisitive with annual M&A budgets of USD1.5 billion-2 billion, but it has a lower appetite for shareholder returns as its dividend payout ratio is lower at 35%-40% and we expect it to spend around USD2 billion on share buybacks. Both Accenture and TCS have no debt and large cash balances.

TCS' business profile is stronger than rated Indian IT peers including Wipro Limited (A-/Stable) and HCL Technologies Limited (A-/Stable), as its scale is substantially larger and it has higher EBITDA margin of 25%-27%. TCS has a similar financial risk profile to Wipro's and HCL's, as all of them have a strong net cash position and generate high and consistent FCF, although TCS has a greater appetite for shareholder return.

DXC Technology Company's (BBB/Stable) business profile is weaker than TCS' as evident from its continued market share loss, revenue declines and execution challenges. In addition, DXC's financial profile is also weaker due to lower profitability and higher leverage. DXC is committed to direct USD5 billion of net proceeds from its announced business divestitures to reduce debt, and Fitch expects its gross debt/EBITDA to be 2.4x in FY22. In comparison, we expect TCS' financial profile to remain strong with no debt and a large net cash position.


Fitch's Key Assumptions Within Our Rating Case for the Issuer

- Revenue to grow by 11%-15% annually in FY22 and FY23

- Operating EBITDA margin of 26%-27% (FY21: 27%)

- Capex/sales ratio at around 2% (FY21: 2%)

- Distribution of most of the pre-dividend FCF via cash dividends and share buybacks


Factors that could, individually or collectively, lead to positive rating action/upgrade:

An upgrade is not likely in the medium term as the SCP would have to improve to a very strong 'a+' for us to rate the IDR at 'A+' given the weaker IHC parent.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- Evidence of TSOL getting better access to TCS' assets or exerting more control over TCS, for example, by having higher influence on TCS' financial policy through higher board representation or action at general meetings

- Substantial weakening of TCS' credit profile, such as market-share losses leading to sustained decline in pre-dividend FCF and/or FFO leverage sustained above 2.0x. However, this is very unlikely.


International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. 


Abundant Liquidity: TCS will maintain abundant liquidity in the next few years. The company had Fitch-defined readily available cash of over INR470 billion at end-September 2021, with no debt. The majority of the cash is invested in government securities and treasury bills. We expect the company to generate annual pre-dividend FCF of over INR300 billion in the next three years, which should be sufficient to fund its cash return policy.


TCS is the largest Indian IT services company by revenue and provides IT services, consulting, digital and business solutions to a diversified global customer base. Its FY21 revenue was around USD22 billion. It has a global delivery model with over 520,000 employees around the world.


The principal sources of information used in the analysis are described in the Applicable Criteria.


Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.

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