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TCS (TCS)
Technology
Delivers—10/10. TCS reported another strong quarter cementing its status as the
industry bellwether further. Even as qoq US$ revenue growth of 7% was a tad lower
than our estimate, margin beat (30.2%, 90 bps higher than estimate) and higher-thanexpected
other income drove a 5.6% beat on net income (Rs23.3 bn versus expected
Rs22.1 bn). Demand indicators continue to support our bullish stance. We increase our
FY2012/13E EPS estimates to Rs54/62.7 and raise TP to Rs1,350. BUY.
Premium to Infosys could sustain; reversal of margin convergence trend poses risk
TCS continues to expand its revenue, operating profit and net income leadership over Infosys.
3QFY11 marked the seventh consecutive quarter when TCS has outperformed Infosys on yoy
EBITDA and net income growth—quarter net income gap between the two companies is now
31% in favor of TCS versus 18% in favor of Infosys only seven quarters back (March 2009). Even
as Infosys has kept pace on revenue growth, TCS has managed to narrow the EBITDA margin gap
versus Infosys to ~300 bps from a peak of 830 bps two years back.
More importantly, immediate reversal of this trend on revenues/EBITDA may not happen—we
remain positive on strong revenue growth outlook for both the companies and pyramid expansion
should serve as a strong margin lever for both in FY2012E. TCS does face an ETR increase
headwind in FY2012E but the same is factored into Street estimates. We also note that Infosys has
seen a sharp increase in non-manpower expenses post the downturn, which TCS hasn’t yet.
3QFY11—another strong quarter
TCS delivered a robust Dec 2010 quarter on most parameters—strong qoq revenue growth (+7%,
0.5% lower than estimate), backed by strong volume growth (+5.7%) and marginal pricing uptick,
OPM expansion of 20 bps qoq (90 bps higher than estimate) despite pressure from Re appreciation
and rent cost normalization, and net income growth of 11% qoq and 30% yoy to Rs23.3 bn,
5.6% above our estimate. More importantly, 3Q results and management commentary provided
solid demand indicators—broad-based growth (except Telecom vertical), strong client metrics,
robust hiring (20,000+ gross hires for the quarter, strong campus hiring numbers), discretionary
spend pick-up trends, deal closures and positive commentary on deal pipeline and pricing outlook.
Raise estimates and target price; reiterate BUY
We raise our EPS estimates for FY2011/12/13E by 2.3/1.5/1.1% to Rs44.4/54/62.7, respectively.
We note that our FY2012E and FY2013E estimates are up despite an increase in ETR assumptions.
Estimate increase is driven by modest upward revisions in revenue as well as margin assumptions.
We raise our target price on the stock to Rs1,350 (Rs1,250 earlier). Our implied target multiple on
TCS is now at a 5% premium to Infosys (10% adjusted for differences in depreciation policy).
A closer look at the source of surprise—margins
Even as TCS’ reported revenues for the quarter were a tad lower than our estimate, the
company surprised on net income. The surprise was driven equally by higher-than-expected
margins as well as other income. TCS’ EBITDA margin for 3QFY11 at 30.2% came in 90 bps
ahead of our estimated 29.3%, despite the expected normalization of rent expenses.
Surprise came in at both the cost of revenues as well as SG&A level. We take a look at both
�� COR—at the COR level, the sources of surprise were lower-than-expected employee costs
and equipment sales. We note that we had expected strong growth in lower-margin
domestic SI revenues, which was not the case, aiding margin surprise. Employee costs line
item movement is a tad surprising—up just 2.5% qoq against a revenue growth of 4.1%
in Re terms. We also note that overall employee base growth of 7.2% qoq was higher
than volume growth (essentially utilization, including trainees, was down) and employee
pyramid was flat. We believe hiring/attrition skew worked in favor of the company.
�� SG&A—at the SG&A level, bulk of the positive variance came in from the bad debt
provision line item. TCS reported a reversal of Rs331 mn (positive impact of 30 bps on
margins) versus our expectation of a charge of Rs400 mn (40 bps)—a swing of 70 bps.
Exhibit 3 depicts quarterly bad debt provision for TCS for the past several quarters.
Other key highlights from the earnings report and management commentary
�� Revenue growth was broad-based except the Telecom vertical (expected to remain weak
for another quarter or two) and India/ LatAm geographies. Growth was particularly strong
in the Hi-Tech (+16% qoq), Media (+23% qoq), Transportation (+14% qoq), BFSI (+8.4%
qoq) and Retail (+7% qoq) verticals. Among geographies, even as US was robust (+6.6%
qoq), non-US geographies fared much better with Europe and EMEA/Asia-Pac (ex-India)
growing double-digit+ sequentially. Consulting (+17% qoq), Infra (+20% qoq), Products
(+26% qoq) and BPO (+12% qoq) led among the service lines, even as ADM segment
reported a modest 3% qoq growth.
�� Management indicated timely closure of clients’ IT budgets—flat to up with a shift
towards discretionary spends and off-shoring.
�� Company indicated a campus hiring target of 37,000 for the ongoing campus placement
season; the company has made 23,700 offers so far and expects its campus hiring to be
complete by mid-Feb 2011.
�� Employee pyramid remains a key margin lever moving into FY2012E; employees with <3
years of experience now form 39% of the total base versus a historical peak of 52%.
�� Attrition trended down sequentially to 17.1% (from 20.3% in 2QFY11) on a quarterly
annualized basis.
�� # of US$100 mn clients increase by 1 (to 9 from 8) and # of US$20 mn clients increase by
10 (to 76 from 66) on an LTM basis.
�� The company indicated a positive pricing outlook and is seeing upticks in select
renegotiations of existing contracts and most new deal signings.
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