2Q11 TCS/INFY Comparison Broad Based, Volume Driven Growth: Janney

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2Q11 TCS/INFY Comparison: Broad Based, Volume Driven Growth
INVESTMENT CONCLUSION:
TCS, an Indian IT services vendor, reported September earnings results above
expectations. We do not cover TCS, but include a comparison of its results to the other
vendors in the space in an effort to hash out industry trends. Both TCS and Infosys
have reported robust, broad based, volume driven September quarter results. Things
look optimistic for the future as hiring guidance was raised along with early, positive
commentary regarding 2011 IT spending. The pricing environment appears to be
improving as well. Our two key takeaways are recent results raise expectations for
September quarter performance from vendors who have not yet reported and early
indications are positive for trends heading into 2011. Our BUY rated names are
Accenture, Infosys, and Cognizant (Our Top Pick) (CTSH-$67.08; BUY).
KEY POINTS:
• Robust volumes drive better than expected sequential revenue growth. Infosys
reported revenue of $1,496.0 mn, a 10.2% sequential increase, above consensus of
$1,430.0 mn and our estimate of $1,422.7 mn. TCS reported revenue of $2,004.2
mn, an 11.7% sequential increase, above consensus of $1,908.8 mn. Volumes
increased sequentially (11.2% for TCS and 7.2% for Infosys) reflecting a demand
environment that continues to improve. We provide a comparison of
August/September quarter results for Accenture (ACN-$45.75; BUY), Infosys,
IBM (IBM-$139.83; NR) and TCS on p4.
• Pricing was flat again for TCS but rebounded 3% for Infosys. Infosys expects
flat pricing going forward in FY11. TCS expects stable pricing near term with
increased pricing toward the end of the year driven by improved demand.
• Growth is broad based across verticals, geographies and services. For Infosys,
BFSI (35.4% of revenue) increased 8.0% sequentially driven by risk management
and regulatory compliance work. Retail (14.4% of revenue) increased 20.5%
sequentially (+19.9% in constant currency) for Infosys primarily due to
multi-channel integration as retail clients reach out to their digital consumers. TCS
reported double digit growth across all verticals with BFSI (44.0% of revenue)
increasing 10.0%.
• Increased FY11 hiring guidance to account for improved demand. Infosys
raised FY11 gross hiring guidance of 40,000 from 36,000. TCS raised gross hiring
guidance to 50,000 from 40,000. Attrition increased 1.3% to 17.1% for Infosys and
1.0% to 14.1% for TCS with both vendors focused on managing attrition going
forward. We continue to believe the most immediate threat to stock
performance is currency fluctuation with the labor environment, pricing, and
utilization all manageable.
• Improved outlook. Both firms noted increased spending from clients with the
intent to cut costs as well as grow the business. FY11 revenue guidance was raised
to 24% to 25% growth from 19% to 21% growth for Infosys. TCS reported a
robust pipeline returning to pre-downturn levels and is optimistic regarding
demand.


VALUATION SUMMARY: Infosys is trading at 24x our raised calendar 2011 earnings estimate of $2.88, below its
pre-downturn (2004-2007) four year 12 month forward average of 25x (30x is the highest forward multiple over this
time period). With industry-leading margins and metrics, we believe Infosys should trade at 27x our calendar 2011
earnings estimate implying a fair value of $78. Risks to our valuation thesis include heightened political uncertainty
and/or deterioration in financial performance, which could result from pricing pressure, a sharp appreciation in the
Indian rupee, greater-than-anticipated wage inflation and/or attrition, difficulties associated with managing growth,
and a slowdown in IT Services spending.