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UBS Investment Research
Tata Consultancy Services Ltd.
Q3 FY11 offers near-term upside potential
�� TCS looks set to outperform in Q3 FY11 as well
We estimate Tata Consultancy Services (TCS) will report revenue of US$2.17bn,
implying 8.3% QoQ growth, ahead of peers Infosys and Wipro. Our estimates are
2% ahead of consensus, which expects TCS’s revenue to grow in line with that of
Infosys. We believe such an outperformance could trigger near-term upside for
TCS’s share price, which will release its results on 17 January 2011.
�� Volume growth likely to remain relatively high despite seasonal weakness
The December quarter is seasonally weak for most large Indian vendors due to the
holiday season in the US and Europe, which are their major markets. We forecast
QoQ volume growth of 7% for TCS, 4.2% lower than in Q2 FY11. Even so, TCS
is likely to be the fastest growing firm among its peers in Q3 FY11.
TCS has so far bucked the margin decline trend in almost all Indian IT vendors. Its
Q2 FY11 EBITDA margin reached a five-year high of 30% despite rising wage
pressures and currency appreciation. We forecast a 40bp decline in its EBITDA
margin in Q3 FY11, which is higher than the 15bp decline we forecast for Infosys
(despite Infosys offering 20,000 job promotions in Q3 FY11).
�� Valuation: maintain Neutral, Q3 could trigger near-term stock upside
We expect TCS to continue its relative outperformance to its peers in Q3 FY11,
which we believe could offer near-term share price upsides. While we maintain our
Neutral rating, we believe the current 7% discount to Infosys’ FY11E PE could
narrow following a strong Q3 FY11. We derive our Rs1,150 price target from a
DCF-based methodology and explicitly forecast long-term valuation drivers using
UBS’s VCAM tool. We assume a WACC of 11.5% and terminal growth of 3%.
TCS likely to grow faster than Infosys in Q3
FY11
TCS has consistently outpaced Infosys in terms of both revenue and volume
over the past six to eight quarters, aided by its significantly larger exposure to
the financial services sector (TCS—44.4%, Infosys—35.8% of revenue in H1
FY11), where IT spending has recovered the most. TCS also grew faster in the
telecom sector (TCS—12.8%, Infosys—13.7% in H1 FY11), which added to the
company’s growth momentum compared to Infosys.
Even after adjusting for greater seasonal weakness (2-3% reduction in volume
due to the holiday season) in volume growth for TCS than Infosys (refer to the
table below), we expect TCS to report higher volume growth in Q3 FY11. We
believe consistent volume growth will help TCS sustain its growth momentum
over the next few quarters as well.
Our margin forecasts are more conservative for TCS
than for Infosys
Over the past eight quarters, TCS has narrowed its EBITDA margin gap with
Infosys from 6-7% to 3.3% currently. We expect margins to come off its Q2
FY11 highs of 30%, and have factored in a 40bp decline in the company’s
EBITDA margin in Q3 FY11. This is higher than our 15bp margin estimate for
Infosys, despite the fact that Infosys will offer 20,000 job promotions in Q3
FY11. We believe our estimates are conservative and offer room for surprise.
PE discount to Infosys has widened, Q3 could trigger rerating
TCS has historically traded at an average 10-15% discount to Infosys. This gap
closed in H2 FY10 as TCS consistently outperformed Infosys in terms of
revenue and EPS growth. While we expect this outperformance to continue, the
PE discount on an FY11 basis has widened to 7% (FY11E PE) over the past
month. We believe TCS’s earnings outperformance over Infosys in Q3 FY11
could again close the PE gap for TCS, in addition to potential consensus EPS
upgrades, leading to near-term share price upside.
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