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India IT Services
Concerns over slip-up in working capital and cash flow
performance in Indian IT overdone; this is a
consequence of growth and tougher YoY comparison
• Cash flow profiles in Indian IT likely to deteriorate relatively in a growth
environment even as EBIT performance looks up. For the 9 month period
ended Dec-10, TCS' operating cash flow was flattish Y/Y, FCF declined by
9% Y/Y while EBIT impressively grew 36% Y/Y. Also, for the 3 months
ended Dec-10 (the latest quarter), TCS’ operating cash flow grew just 9%,
FCF stayed flat, while EBIT impressively grew 35% - all Y/Y.
• Are we worried by this? No, because in growth mode, working capital
needs tend to increase besides (of course) capex. TCS’ receivables position
has increased for reasons of business expansion. Also, the increase in working
capital could also be partly due to lower accounts payable as % of revenues as
TCS may been less strict with vendors (versus the downturn). In addition,
companies have likely incurred pre-payments made to vendors towards buildout
of SEZs which will normalize itself in the course of time (some part of a
sudden increase in assets that resulted in working capital increase for HCLT in
the previous Sep-10 quarter did not repeat in the Dec-10 quarter, for instance).
• Ironically, cash flow performance for Indian IT (Infosys, TCS) hit a peak
at about the time of the depth of crisis as they cut back on capex, tightened
receivables, made vendor terms stricter and simply clamped down on anything
oriented towards growth. During that period (FY09-10), Infosys' pre-tax free
cash flows as % of revenues also shot significantly upwards of 30% peaking at
35% in FY10, which is unlikely now and indeed, unrealistic to expect in a
growth environment of today. For YTDFY11, Infosys' pre-tax free cash flows
at 28% of revenues is a good 7% points below peak free cash flow
performance (pre-tax considered to strip out impact of increased tax rates).
• Thus, in our view, weak or insipid Y/Y performance of cash flow and freecash
flow performance in CY10 versus CY09 reflect (a) investments in
business expansion and (b) tougher Y/Y comparison benchmarks in 2009
(2009 being a year of clamp-down and constriction).
• We think that as long as firms generate sufficient cash flows in absolute
terms to meet their growth and reinvestment needs besides saving for a
rainy day, we should not be too concerned about the expansionary-related
slip-up in working capital and free cash flow performance (our top pick,
TCS (OW), still generates over USD 1.3 bn in free cash flows annually).
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
India IT Services
Concerns over slip-up in working capital and cash flow
performance in Indian IT overdone; this is a
consequence of growth and tougher YoY comparison
• Cash flow profiles in Indian IT likely to deteriorate relatively in a growth
environment even as EBIT performance looks up. For the 9 month period
ended Dec-10, TCS' operating cash flow was flattish Y/Y, FCF declined by
9% Y/Y while EBIT impressively grew 36% Y/Y. Also, for the 3 months
ended Dec-10 (the latest quarter), TCS’ operating cash flow grew just 9%,
FCF stayed flat, while EBIT impressively grew 35% - all Y/Y.
• Are we worried by this? No, because in growth mode, working capital
needs tend to increase besides (of course) capex. TCS’ receivables position
has increased for reasons of business expansion. Also, the increase in working
capital could also be partly due to lower accounts payable as % of revenues as
TCS may been less strict with vendors (versus the downturn). In addition,
companies have likely incurred pre-payments made to vendors towards buildout
of SEZs which will normalize itself in the course of time (some part of a
sudden increase in assets that resulted in working capital increase for HCLT in
the previous Sep-10 quarter did not repeat in the Dec-10 quarter, for instance).
• Ironically, cash flow performance for Indian IT (Infosys, TCS) hit a peak
at about the time of the depth of crisis as they cut back on capex, tightened
receivables, made vendor terms stricter and simply clamped down on anything
oriented towards growth. During that period (FY09-10), Infosys' pre-tax free
cash flows as % of revenues also shot significantly upwards of 30% peaking at
35% in FY10, which is unlikely now and indeed, unrealistic to expect in a
growth environment of today. For YTDFY11, Infosys' pre-tax free cash flows
at 28% of revenues is a good 7% points below peak free cash flow
performance (pre-tax considered to strip out impact of increased tax rates).
• Thus, in our view, weak or insipid Y/Y performance of cash flow and freecash
flow performance in CY10 versus CY09 reflect (a) investments in
business expansion and (b) tougher Y/Y comparison benchmarks in 2009
(2009 being a year of clamp-down and constriction).
• We think that as long as firms generate sufficient cash flows in absolute
terms to meet their growth and reinvestment needs besides saving for a
rainy day, we should not be too concerned about the expansionary-related
slip-up in working capital and free cash flow performance (our top pick,
TCS (OW), still generates over USD 1.3 bn in free cash flows annually).
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