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TATA CONSULTANCY SERVICES
Moving from strength to strength
Tata Consultancy Services (TCS) once again delivered a stellar performance.
Volume growth of 5.7%, USD revenue growth of 7.0%, constant currency
pricing improvement of 120bps, operating profit margin expansion of 20bps
and net profit growth of 11% sum up the quarter’s performance. With
12,500 net employee additions on the back of 11,000 additions last quarter,
TCS’ revenue visibility continues to improve. Most importantly, TCS’ results
over the past six quarters have carried one common theme ‘consistency’ -
across major markets, verticals and client segments.
Pricing improvement and pyramid broadening major margin levers
With TCS’ EBITDA margin at 30.2%, there is high concern about its ability to
sustain the same. However, going into FY12, we believe pricing improvement
(already witnessed in the current quarter) and broadening of employee pyramid
are major margin levers. While a sudden surge in demand and high attrition
narrowed the employee pyramid (0-3 yr exp proportion at 39%), we see high
trainee additions (37,000 planned in FY12) and declining attrition to lower per
employee cost. In addition, pricing increase will act as a major margin cushion.
Thus, we build only 40bps margin decline in FY12 at 29.4%.
Growth coming from high scale opportunity horizontals
We note that TCS’ performance in all three quarters of FY11 is essentially driven
by strong growth in assurance, infrastructure and BPO segments. These three
services have contributed 37% to incremental revenues, despite their collective
contribution at 27%. Cross selling and increasing share in renewal markets has
led to this significant increase. With deal renewal happening in infrastructure
services, BPO and ADM, we continue to see TCS winning large fair share with its
end-to-end full service offerings in large deals.
Deal momentum remains strong
Even in a seasonally slow quarter, TCS won nine large deals, better than eight
won in the previous quarter. Management expects deal wins to remain strong on
the back of healthy pipeline.
Outlook and valuations: Earnings upgrade continues; maintain ‘BUY’
At CMP of INR 1,137, the stock is trading at P/E of 25.9x and 21.4x for FY11E
and FY12E earnings, respectively. We continue to prefer TCS with its
earnings growing at 25% in FY11E (12% for Infosys) and continued
earnings upgrade seen for FY12. We maintain ‘BUY/Sector Outperformer’.
Key highlights
• Revenues, at INR 96.6 bn, were up 4.1% Q-o-Q and 26.3% Y-o-Y. Sequential growth
was driven by volume growth of 5.7% Q-o-Q. In USD terms, revenues grew 7% to
USD 2,144 mn. In constant currency terms, the company delivered 6% sequential
growth.
• Gross profit for the quarter stood at INR 45.4 bn, up 4.7% Q-o-Q. Gross margin
improved 20bps and stands at 47%.
Operating margin sustains: TCS’ operating margin (EBIT) was flat Q-o-Q and
currently stands at 28.1%. The negative currency impact of 1.1% on margin was offset
by pricing and productivity improvement apart from offshore shift.
• Net income: TCS reported net income of INR 23.3 bn, up 10.6% Q-o-Q. Net profit
margin increased by 140bps, mainly on account of higher other income, and now
stands at 24.1% versus 22.7% in the previous quarter.
• Geo split: Strong growth was seen across geographies, except India and Latin
America. North America and UK grew 6.6% and 11.9%, respectively, while
Continental Europe grew 9.3% and APAC 19.1%, Q-o-Q. India and Latin America
were down 0.6% and 15.0%, respectively, Q-o-Q due to project conclusion and
absence of follow through project.
• All-round performance across verticals: All verticals except telecom reported
sequential growth this quarter, with strong traction seen in media & entertainment,
hi-tech, transportation and life sciences. BFSI grew 8.4% Q-o-Q in USD.
• Broad-based growth across service lines: Growth was seen across horizontals
except enterprise solutions that declined marginally. Five horizontals namely,
assurance services, infrastructure services, BPO, asset leveraged solutions and global
consulting reported more than 12% Q-o-Q growth
• Client metrics: TCS added 35 new clients (30 in Q2) during the quarter versus 40
for Infosys. The active clients count stood at 959 versus 936 in the previous quarter.
The number of USD 1 mn clients increased by 14 to 434; there was an increase in
USD 5 mn (8), USD 10 mn (8), USD 20 mn (10) and USD 100 mn (1) client bracket,
over the previous quarter.
• Hiring momentum continues: Gross addition of 20,219 was the highest ever, while
net addition was 12,497. Total headcount stands at 186,914. Attrition on TTM basis
for the quarter stood at 14.4 versus 14.1 in the previous quarter. However absolute
number of people leaving the company declined by 13% Q-o-Q.
• Continued traction in large deals: The company won nine large deals during the
current quarter in addition to eight in the previous quarter.
• Utilisation rate (excluding trainees) was flat at 83.8%; including trainees, it dipped
marginally by 60bps to 77.1%.
• Offshore revenue contribution was up 30bps at 51%.
Company Description
TCS is India's largest and one of its oldest IT companies. It commenced operations in
1968 and provides a comprehensive range of IT services to industries such as banking
and financial services, insurance, manufacturing, telecommunications, retail, and
transportation. With a presence in 42 countries, TCS is positioned to deliver its services
seamlessly. TCS has a large diversified client base (930 active clients), which include
seven Fortune Top-10 companies. TCS’ employee force stands at 186,914 (including
subsidiaries) and its revenues for the last twelve months (TTM) stood at INR 349 bn
(USD 7.6 bn).
Investment Theme
As India's largest and most-experienced IT services firm, TCS is well-positioned to
benefit from the growing demand for offshore IT services. It is a serious contender for
winning large deals, as it has more experience than peers in implementing large,
complex, and mission-critical projects. TCS has multiple margin levers at its disposal,
which we believe, will sustain its margins, shielding it from continued pressures on
account of wage increases across the industry. End-to-end full services offerings, traction
in emerging markets, ability to roll up large acquisitions, improving sales and marketing
prowess and willingness to take multiple big bets (different go-to-market models) are
among the key rationales for TCS to sustain its long term hi-growth trajectory.
Key Risks
Key risks to our investment theme include – double dip recession in major market US
and prolonged slowdown in Europe, sharp cross currency movements and appreciation of
rupee against USD, Euro and GBP and maintaining the margins, while pursuing large
deals and while pricing pressures remain.
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