TCS: Upfront discretionary commitments seen in CY11 budgets:: Edelweiss

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TCS (TCS IN, INR 1,167, Buy)

Our recent meeting with TCS reinforces our positive view on the demand scenario and the company’s ability in sustaining its growth momentum. We present below our key takeaways from the meeting -  

Upfront discretionary commitments seen in CY11 budgets

Unlike CY10, TCS has witnessed significant discretionary spent commitment at the earlier stage of discussion with its key accounts during customer meets in different geographies. IT spend during CY10 was on cautionary note while in CY11 demand is clearly looking up. TCS is quite confident of its growth going into FY12 as its book to bill ratio continues to improve and believes that high growth in FY11 is not a one-off or driven by pent up demand, which will soften in FY12. Conventional cost take out remains the key growth drivers for services like IS, BPO, ADM; for ES, consulting and PI, revenue enhancement is the driver.  

 Seasonal headwind to remain for Q3FY11

With December quarter categorized with lower working days (3% lower than September), volume growth is likely to be impacted for the quarter by similar magnitude. Also, budget flush is unlikely, as CY10 spending has been in line with budget. Moreover, the current quarter is likely to bear the impact of stronger rupee as well. We expect margins to decline by 100-120bps in Q3FY11, with 7-8% effort-based volume growth.  

Operating margins likely to sustain for FY12 at 27%

Overall, what we see as a key positive in TCS’ growth story is the sustainable improvement in operating margins (EBIT), at 27%. Cost management remains the key focus area, while cost rationalisation is behind. We expect FY12E operating margins to sustain at 27%, as pricing and employee pyramid changes will absorb the salary hikes into next year. Further, declining attrition could impact margins positively.     

Outlook and valuations: Offering long term visibility; maintain ‘BUY’

We continue to maintain our 22% USD growth assumption for FY12 (implying 3.8% CQGR over Q1-Q4FY12) on top of 30% expected for FY11E. Our EPS estimate stands at INR 42.7 and INR 48.4, at which the stock is trading at P/E of 27.4x and 24.1x, for FY11 and FY12, respectively. We maintain ‘BUY/Sector Outperformer’ on the stock.