Credit Suisse:: Tata Consultancy Services-Yet another strong quarter: OUTPERFORM

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Credit  Suisse:: Tata Consultancy Services-Yet another strong quarter: OUTPERFORM

● TCS’ Dec-10 revenue and EBIT were ~1% ahead of our numbers,
while EPS came in 7% ahead, largely due to higher other income.
Strong volume growth (5.7% QoQ) was a good surprise coming
after a rather lacklustre (3.1% QoQ) volume growth by Infosys.
● TCS’ margins continue to benefit from write-back of bad loans
(+30 bp in Dec-10 quarter). This continues to surprise us and
should revert to mean (~30-50 bp write-off). Excluding this, EBIT
would have been in line with our numbers.
● For 9M FY3/11, TCS’ EPS growth (27% YoY) has outperformed
Infosys’ (8% YoY), largely due to margin catch-up and significant
increase in Infosys tax rates. Assuming normalisation of tax rates
and loan write-back, we believe Infosys’ EPS growth could
outperform TCS’ in FY3/12.
● We believe that the environment remains highly favourable to Indian
IT vendors and expect strong revenue growth to continue.
Valuations are reasonable, and hence we expect TCS to continue to
OUTPERFORM. We maintain our target price of Rs1,325 for TCS.
Excellent results
TCS reported excellent Dec-10 results. Revenue grew 4.1% QoQ to
Rs96.6 bn. In dollar terms, revenue growth was 7.0% QoQ, ahead of
our estimate of 6.1% QoQ. EBIT margins benefitted from offshore shift
(23 bp), rate productivity and SG&A leverage (90 bp), which negated
the impact of currency (112 bp). Further, loan write-back helped
margins by 30 bp. EPS was 6.7% ahead due to higher other income.
Growth driven by both volume, pricing
Revenue growth was led by both volume growth of 5.7% QoQ and
pricing improvement of 1.2% QoQ  in CC terms. Similar to Infosys,
management explained that price increase was largely like-to-like.


Continued positive outlook
Management indicated that discretionary spending had slowed in 3Q
due to seasonality and could pick up going forward. It remained
positive on outlook and mentioned that majority of the customers are
increasing IT budgets in 2011 leading to a strong pipeline. The
company also expects discretionary spending to improve going
forward. This is consistent with recent commentary by Infosys,
Accenture, SAP and Oracle. TCS also expects pricing to move up
going forward.
TCS expects flattish margins and 23% tax rates in FY3/12.
Better EPS growth than Infosys due to margin
improvement, better tax rates
While Infosys’ revenue growth has been broadly in line with TCS for
9M FY3/11, TCS’ EPS growth at  27% is significantly higher than
Infosys at 8%. We note that this is largely due to margin gap
compression by 270 bp (in TCS’ favour). TCS was also helped by an
increased tax burden for Infosys and better other income.
Given limited margin gap (190 bp in 9M FY3/11), the possibility of
reversal of bad loan write-back (25 bp in 9MFY3/11) and an increased
tax rate (23% in FY3/11 versus 20% in 9M FY3/11), we believe that
TCS’ EPS growth is unlikely to be higher than Infosys’ in FY3/12.
Reiterate OUTPERFORM
Comments from both TCS’ and Infosys’ management point to a very
robust demand outlook. With a 25% EPS CAGR (expected) over the
next two years, we do not find the stock expensive at 21x FY12
earnings. We reiterate our OUTPERFORM rating and our target price
of Rs1,325.