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Tata Consultancy
Dec10: In Line Results; FX
Gains, Lower Taxes Drive Earnings Outperformance
Quick Comment: We maintain our EW rating on TCS.
TCS has been delivering on expectations for the last few
quarters and the stock appears to be fairly priced.
Earnings outperformance in the December 2010 quarter
has been driven by non-operational items like FX gains
and lower tax rates versus our forecasts. We prefer to
wait for a more attractive entry opportunity in the stock.
What we liked? 1) Strong volume growth of 5.7%qoq
and price improvement of 1%qoq. 2) Management
expects client budgets to be flat to up for 2011 and
believes that discretionary spending could pick up from
the June 2011 quarter. 3) TCS travel, communication,
depreciation and other miscellaneous costs have
normalized in 3Q.
What concerned us? TCS plans to continue operating
at high 84% utilization levels. We believe the high rates
could limit TCS’s ability to drive revenues beyond a point
in the event of better than expected spending in 2011. It
would be interesting to see if TCS plans to further push
up its utilization into the mid –high 80s. TCS added
12,500 employees in 3Q at an average cost of $20k per
person versus its average of $25,500/person.
Financials: The stock trades at 23xFY12e and 19x
FY13e EPS for 18% EPS CAGR over FY11-13e. For
TCS to outperform from current levels, it will have to add
US$2bn and US$2.5bn in revenues over the next two
years, which appears to be steep to us. For TCS, we
forecast a 24% US$ revenue growth with ~27% EBIT
margins leading to a 18% EPS CAGR over FY11-13e.
Key Results Positives
1) Despite a higher base TCS continues to grow its
US$ revenues ahead of Infosys (INFY.BO; Rs3,267.95; OW)
For the last three consecutive quarters.
2) TCS improved price realizations by +1.18% QoQ in 3Q11
and expect pricing to be stable with an upward bias going
forward.
Key Results Negatives
1) Infosys maintained its EBIT margins QoQ in December
2010 quarter, despite bringing down its utilization rates
(excluding trainees) while TCS maintained margins QoQ with
stable utilization rates.
2) Telecom revenues (excluding media and entertainment)
declined -0.5% QoQ for TCS. Excluding India, Telecom
Key Conference Call Takeaways
1) Management indicated that although macro environment
remains dynamic, demand environment continues to look
good.
2) TCS expects clients’ IT spend in 2011 to remain flat to up.
3) TCS has made ~50,000 gross additions so far in 9m FY11,
TCS expects to hire another 12000-15000 employees in 4Q.
4) Expects to give 37,000 offers for FY12e out of which
~23692 offers have already been given so far.
Other Highlights
1) Cash from operations at US$557m (+40% QoQ, +25%
YoY) improved to 26% of revenues for TCS.
2) Cash and cash equivalents of US$1248m.
TCS and Infosys Comparison
1. BFSI and retail revenues grew strongly by 8.5% QoQ and
7.2% QoQ respectively in line with Infosys. Currently TCS
retail revenues are at run rate of ~US$940m, which is similar
to Infosys
2. Manufacturing lagged for TCS and grew 4.7% QoQ
compared with 9.5% QoQ for Infosys. Infosys manufacturing
revenues are at US$310m, which is 2x of TCS.
3. Telecom revenues lagged for both TCS and Infosys. TCS
telecom revenues (incl. media and entertainment) grew at 3%
QoQ vs Infosys -0.5% QoQ.
4. TCS saw maximum margin decline in telecom vertical while
Infosys had maximum margin improvement in Telecom
vertical.
5. Europe revenues continued to grow ahead of US revenues
for both TCS and Infosys.
6. TCS receivables and unbilled revenues increased by 6%
QoQ to 23% of revenues while Infosys' receivables and
unbilled revs stand at 18.7% of revenues
7. TCS maintained its utilization rates (excluding trainees) at
83.8% (flat qoq) while for Infosys utilization rates declined to
81.8% (-110bps QoQ)
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Valuation: Historically, TCS has traded in the range of 6x-27x
one year forward EPS with an average of 18x. Currently, the
stock is trading at 23x FY12e EPS and 19x FY13e EPS, which
is on par with Infosys. We expect the stock to remain
range-bound in the near term.
Our 12-month price target is Rs985: Our price target is derived
from the probability weighted average of our risk-reward
scenarios: (PT Rs985 = 30%*Rs1150+ 60%*Rs965+
10%*R610). It now implies a P/E of 20xFY12e EPS.
Upside risks: 1) Any sharp rupee depreciation, 2)
improvement in financial services in the US, which accounts
for 53.5% of revenues − the banking, financial services and
insurance (BFSI) sector represents 45% of revenues; 3)
better-than-expected margins in the software business; 4)
large deals; 5) M&A gains.
Downside risks: 1) Client-specific issues could affect
revenue growth/margins; 2) Non-extension of STPI tax
holiday; 3) currency risks, and 4) acquisition-related risks
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