TATA CONSULTANCY SERVICES: Sept Qtr review: Picture perfect:: Edelweiss

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Tata Consultancy Services (TCS) could not have delivered a better quarter
than this one, every time superseding the earlier threshold. Q2FY11 has
been an almost perfect quarter with no blemishes. “Profitable growth” has
been the key theme that TCS delivers from this strong set of numbers,
coming on top of an already strong Q1FY11. The company has fired on all
cylinders simultaneously - handsome revenue and margin performance,
volume growth of 11% Q-o-Q, eight large deal wins spread across sectors,
highest ever organic gross/net employee addition of 19,293/10,717,
sequential growth of 10% plus across verticals & most clients, and most
importantly, EBITDA margin improvement by 70bps to 30% (historic high).
􀂃 Revising up EPS estimates; initial signs of next year budget seen up
We see upgrade in consensus EPS numbers for TCS, despite the appreciating
INR. We are revising up our EPS by 4% for FY11 and 6% for FY12 to INR 42.6
and INR 48.4, respectively. Also, the CEO remarked about the likely increase in
IT budgets for the next fiscal based on preliminary discussions with a small set
of clients. “Growth agenda” and “being efficient” are key themes driving the IT
spending at client organizations in the current environment.
􀂃 Closing margin gap to Infosys; EBIT difference now only 220bps
We see that the most impressive part of TCS’ performance over the past 4-6
quarters is its ability to rigorously close the margin gap with Infosys. TCS’ EBIT
margin has expanded over 300bps since the start of the last fiscal. At the same
time, we see advantages such as market diversity (horizontals), geographic
diversity, end-to-end service offerings, and ability to bag large, bundled deals
among others playing in harmony currently.
􀂃 Outlook and valuations: Firing on all cylinders; maintain ‘BUY’
At CMP of INR 986, the stock is trading at a P/E of 23.2x and 20.4x for FY11E
and FY12E earnings, respectively. With consistent outperformance on revenues
(Q-o-Q) and strong margins, we see TCS’ valuations improving further and
possibly entering the premium zone to that of Infosys. We maintain ‘BUY’ on the
stock and rate it ‘Sector Outperformer’ on relative returns.