Motilal Oswal: TCS 2QFY11: Operating performance above expectation; Upgrading estimates

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TCS 2QFY11: Strong topline on broad-based demand traction; Operating performance above expectation; Upgrading estimates

TCS’ (TCS IN, CMP Rs984, MCap US$42.6b, Neutral) 2QFY11 results beat estimates with strong topline growth of 11.7% (v/s est. of 4.7%) in US$ revenues QoQ driven by double digit growth across geographies and verticals; operating performance above expectations with 86bp improvement in EBIT margin (v/s est. of 10bp decline). Key highlights:

11.7% sequential growth in revenues to US$2b grew (v/s est. of 4.7% QoQ) driven by 11.2% QoQ growth in volumes (v/s est. of 5.3%).

c172a50186a0284d25bbfa5e81f8aaee Strength in demand environment pervasive in the results: (a) 8 large deals in 2QFY11 (v/s 9 large deals by Infosys in 1HFY11); (b) strong discretionary traction evidenced by growth in Enterprise Services; (c) Healthy pipeline in large and transformational deals (pursuing 11 deals) and (d) increase in hiring guidance from 40k to over 50k (v/s increase from 36k to 40k at Infosys)

1 Margin headwinds on currency appreciation (40bp impact on margins on every 1% swing in currency); cushioned by: (a) continued traction in volumes growth; (b) higher utilization and (c) continued cost management aggression

Management guidance of: (a) possible increase in pricing towards end of FY11 as demand environment continues to remain healthy and (b) higher IT budgets in CY11 as per early indicators from clients

-          We have upgraded our FY11 and FY12 estimates in line with:  Strength in the current demand environment; c172a50186a0284d25bbfa5e81f8aaee continued impressive delivery on operating performance, and 1 expectation of sustainable margins at current levels going forward.

-          We have increased our FY11 US$ revenue growth estimate by 5.9% to 26.9%; and FY12 estimate by 3.9% to 22.7%. We have upgraded our FY11 EPS estimate by 3.2% to Rs42.3 and FY12  EPS estimate by 13.7% to Rs50.6

-          We expect TCS to report revenue CAGR of 25% over FY10-12 and EPS CAGR of 20% over this period.

-          The stock trades at 20.5x FY11 and 19.6x FY12 earnings. Maintain Neutral.

US$ revenue growth of 11.7% QoQ, EBIT margin up 86bp QoQ to 28%

-          USD revenue growth of 11.7% to USD2,004m v/s estimate of 4.7% growth (Infosys growth of 10.2%)

-          Volume growth of 11.2% QoQ (v/s est. of 5.3% QoQ and Infosys at 7.2% QoQ)

-          INR revenues at Rs92.9b grew by 13% QoQ (v/s est. of Rs87.4b)

-          EBITDA margin improved 70bp QoQ to 30% (v/s est. of 20bp decline), driven by SGA as % of sales (incl. depreciation) declining by 50bp to 17.4% (v/s est. of 17.9%)

-          EBIT margin improves 86bps to 28% v/s estimated decline of 10bps to 27%

-          SGA as % of sales (incl. depreciation) declined by 50bp to 17.4% (v/s est. of 17.9%)

-          Other income at Rs0.3b (v/s est. of Rs0.9b), due to forex losses of Rs0.5b

-          Effective tax rate of 18.9% (v/s est. of 19%)

-          Profit after tax at Rs21.1b, up 14.2% QoQ (v/s est. of Rs19.6b). 2QFY11 EPS at Rs10.76 (v/s est. of Rs10).