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Tata Consultancy
Gaining wallet share
We are positive on TCS's growth outlook even after earnings surprises over the
past several quarters. Given its increasing revenue wallet share, we expect
revenue growth to remain strong in the coming years. We initiate with a Buy.
Despite increasing base, revenue growth to remain strong
We believe the opportunity for renewal of US$174bn of large IT/BPO outsourcing deals
within the next two years will keep TCS’s revenue visibility high given TCS’s increasing
revenue wallet share from large deals. We also believe TCS’s revenue growth will remain
strong despite its high base and consistent outperformance in recent quarters, thanks to the
company’s higher revenue weighting toward high-growth verticals including BFSI (banking,
financial services and insurance) and retail (combined contribution of more than 55% of
revenue), increasing wallet share in emerging verticals (where we believe global sourcing
potential is higher) and improving client mining. Given all of the above, we expect TCS’s
USD revenues to show at a 23% CAGR for FY11-13F.
Any margin decline from here on looks unlikely to be sharp
We believe TCS has done a creditable job in improving EBITDA margins by a significant
630bp over the past 10 quarters. This has resulted in positive earnings surprises. In this
transition, most of the headroom in margin levers (including utilisation, offshoring, SG&A
leverage) has been utilised at optimum levels. However, with strong volume visibility, we
expect economies of scale to continue and we expect lower-margin downside vs some of
TCS’s peers in our coverage universe.
Initiate at Buy
We are optimistic about TCS’s growth outlook, given its increasing revenue wallet share from
large deals and client mining. Despite several quarters of positive earnings surprises, we
expect revenue growth to remain strong. We also believe margin downside from here on is
likely to be lower than that of some of its peers. We initiate coverage at Buy, with a target
price of Rs1,350 (upside potential of 14%) implying a target PE multiple of about 22x FY13F
vs an EPS CAGR of 18% for FY11-13F. Our target price implies a target EV/EBITDA multiple
of about 15x FY13F (vs an EBITDA CAGR of 20% for FY11-13F).
The basics
Catalysts for share price performance
We expect the key near-term catalysts to be:
Higher growth in outsourcing and offshoring as TCS’s clients finalise their CY11 IT budgets.
We expect TCS to gain the most vs its peers considering its large focus on high-growth
verticals, including BFSI and retail. TCS’s increasing revenue wallet share in emerging
verticals should keep revenue growth momentum high.
Cognizant’s guidance for CY11 (in February 2011). Infosys’s guidance for FY12F in April
2011. While building in its typical conservatism, we expect Infosys to take a more confident
stance on FY12 guidance.
The renewal opportunity for large outsourcing deals worth US$174bn over the next eight
quarters beginning with 4QCY10 (about US$90bn in renewals due in 4QCY10-3QCY11F). We
expect TCS to be a major winner, based on its increasing wallet share of large deals.
Higher growth in discretionary spend for the IT industry would add to revenue growth
momentum in FY12F vs FY11F for TCS (discretionary services contributes more than 40% of
TCS’s revenues).
A pick-up in demand momentum from Europe (in addition to continuing momentum from the
US), with expected higher outsourcing, should benefit TCS, considering its large base in
Europe vs its peers and its higher traction in public sector verticals in the UK.
Earnings momentum
With TCS’s 1) increasing wallet share in large deals, 2) higher revenue weighting on highgrowth
verticals including BFSI and retail (combined contribution of more than 55% of
revenues) and 3) increasing wallet share in emerging verticals, we believe its revenue growth
will remain strong in the next few years.
We believe TCS has done a creditable job in improving its EBITDA margins by a significant
630bp over the past 10 quarters. In this transition, most of the headroom in margin levers has
been used at optimum levels. However, with strong volume visibility, we expect economies of
scale to continue and we expect lower margin downside vs some of TCS’s peers we cover.
Our forecasts assume USD revenue, INR EBITDA and INR EPS CAGRs of 23%, 20% and
18%, respectively, for FY11-13.
Valuation and target price
We value TCS based on a PE multiple derived as a premium to Infosys (which we take as our
industry benchmark). We initiate with a Buy rating and target price of Rs1,350, implying target PE
multiple of 22x FY13F and a target EV/EBITDA multiple of about 15x FY13F. Our target PE
multiple is at a premium of about 7% to Infosys’s target PE multiple (vs the current valuation
premium of 12-13% for FY12F and FY13F), which we believe is fair considering TCS’s consistent
increase in revenue wallet share (even on a high base), as well as significant improvement in
margins vs peers (including Infosys) despite similar macro parameters driving each peer’s
revenue and earnings growth.
How we differ from consensus
Our FY12 and FY13 EPS forecasts are almost in line with Bloomberg consensus. Given our
expectations of strong revenue momentum, we do not rule out further upside.
Risks to central scenario
Any further deterioration in the macro environment in western economies, as the US and
Europe contribute more than 80% of TCS’s revenues.
A sharp appreciation of INR vs the USD would be significantly negative for revenues and
hence margins/EPS, as would a sharp depreciation in EUR, GBP and AUD vs the USD.
Fiscal austerity and resulting protectionism measures in western economies.
Expect robust revenue growth to continue
With increasing revenue wallet share, as well as significant opportunity from renewal of
large outsourcing deals (due in the eight quarters beginning in 4QCY10), we expect TCS to
continue to report strong revenue growth in the coming years.
We believe the opportunity from the renewal of large outsourcing deals worth US$174bn in the
next two years will keep revenue visibility high given TCS’s increasing revenue wallet share from
large deals. We also believe revenue growth will remain strong in the coming years, given the
company’s higher revenue weighting in high-growth verticals, including BFSI and retail (combined
contribution of more than 55% of revenues), increasing revenue wallet share in emerging verticals
(where global sourcing potential is higher) and improving client mining. This is despite its high
base and consistent revenue growth outperformance in recent quarters. Given the above drivers,
we expect TCS’s USD revenues to show a 23% CAGR for FY11-13.
High base having no impact on growth
Despite the high base, TCS has outperformed all Indian IT large-cap peers in revenue terms, as
well as in terms of margins post 1QFY10A (the quarter that first showed signs of stabilisation of
recessionary pressure). We believe this was largely due to the company’s: 1) increasing
dominance in BFSI, 2) increasing traction in emerging verticals (which are non-traditional verticals
excluding BFSI, manufacturing, retail, telecom/high-tech, etc), 3) mining the existing client base,
and 4) higher growth through non-linear initiatives, including products.
The preceding table indicates that TCS is poised to gain more than its peers from the US$174bn
worth of large outsourcing contracts expected to be up for renewal over the next two years. With
an increasing trend of deal restructuring/renewals within ADM (application development and
maintenance) combined with IMS (infrastructure management services), we believe TCS will be a
preferred vendor, given its 3QFY11A annualised revenues already exceed US$4.5bn in these two
services alone. However, with other players, including HCL Tech, catching up, we believe these
services are likely to be highly competitive going forward.
TCS focus on client mining has improved significantly
We believe that one of the reasons for TCS’s recent revenue growth outperformance is its
increasing focus on client mining. Despite Infosys continuing to lead in client mining, TCS
registered 6.1% compounded qoq growth in average revenue per active client over 1QFY10-
3QFY11 (the highest among the top three India IT large caps). With TCS’s dominance in most
traditional services, we believe this focus will lead to further stickiness with clients.
Infosys and TCS derive the highest revenues from high-growth verticals (BFSI, retail)
Our macro analysis indicates that BFSI, retail and, to some extent, manufacturing are likely to
provide improved growth opportunities even beyond CY10 for Indian IT, with most global
companies operating in these verticals likely to register high-single-digit to double-digit growth in
revenue/earnings in CY11-12F (see Chart 4, 5 and 8 in our sector note). Given TCS’s highest
revenue contribution is from these verticals, we believe its deal pipeline is likely to continue to be
robust.
All-around positioning
Despite increasing revenue wallet share in large traditional verticals including BFSI, TCS has also
been gaining wallet share in emerging verticals (emerging verticals include energy/utilities,
media/publishing/entertainment, healthcare, life sciences, services and others), as shown in Table
5. Given the significant opportunity for global outsourcing within emerging verticals, we believe
TCS’s wallet share in large deal wins is likely to remain robust. This makes us more confident in
our estimates for continued revenue growth momentum beyond FY11.
Margin decline unlikely to be sharp
Despite limited headroom to improve margins going forward, we expect no major margin
decline and expect TCS’s margin performance to exceed Wipro’s even in the next few
years.
We believe TCS has done a creditable job in improving its EBITDA margins by a significant 630bp
over the past 10 quarters, a big driver for the earnings surprises over the past several quarters.
During this industry leading margin improvement over the last 10 quarters, most of the headroom
in margin levers (including utilisation, offshoring, SG&A leverage) has been utilised at optimum
levels. We agree that a material portion of the increase in the offshore revenue contribution over
1QFY09-3QFY11 was due to the acquisition of TCS e-Serve (effective 4QFY09). However,
excluding this, improvement in organic offshoring is also steep at more than 700bp.
We believe Infosys’s margin headroom is better than that of its peers. However, comparing TCS
and Wipro, we believe TCS’s high revenue growth visibility will continue to drive relatively high
economies of scale and, thus, we expect better earnings growth in TCS vs Wipro going forward.
Initiating coverage at Buy
We initiate on TCS with a Buy rating as we expect its industry-leading revenue growth to
continue in the next few years and we see better earnings visibility than at some of its
peers. TCS is our second pick after Infosys among our top three large caps.
The revenue wallet share of the Indian large-cap IT companies has been gaining increasing
weight in their respective fair value multiples and the resulting premium or discount to peers, as
they all share macro drivers for growth and have a high revenue base. We expect TCS to trade at
a slight premium to Infosys for the foreseeable future because of its consistent gains in revenue
wallet share (even from a high base) and its significant catch-up to near Infosys’s EBITDA
margins (especially in its international business, which comprises about 91% of its revenues, vs
up to 98% for Infosys). We believe TCS’s revenue growth momentum will continue in the coming
years and we cannot rule out upgrades to our growth estimates.
Hence, we initiate coverage with a Buy rating and a target price of Rs1,350 implying a target PE
multiple of 22x FY13F (vs an EPS CAGR of 18% over FY11-13F) and a target EV/EBITDA
multiple of about 15x FY13F (vs an EBITDA CAGR of about 20% for FY11-13F). Our target PE
multiple is at a premium of about 7% to our target for Infosys (vs the current valuation premium of
12-13% for FY12F and FY13F), which we believe is fair considering TCS’s consistent growth in
revenue wallet share and significant improvement in margins vs peers (including Infosys) despite
similar macro parameters driving each peer’s revenue and earnings growth.
Management team
Tata Group holds a 74.1% equity stake in TCS, which is managed professionally. Mr N
Chandrasekaran, the CEO and Managing Director has been with TCS for more than 20 years
and, during his time in charge, the company has posted industry-leading revenue growth rates
with a compounded qoq USD revenues growth rate of about 7% from 3QFY10 to 3QFY11. The
company also has a strong second line of senior managers heading various business segments.
TCS is India’s leading IT services company, with a 3QFY11 annualised revenue run rate
exceeding US$8.5bn. It has been consistent in dividend payment, with a payout ratio of 25-30%
for FY08-09. For FY10, in addition to a final dividend payout, TCS announced a special dividend,
resulting in a total dividend payout of about 57% for FY10.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Tata Consultancy
Gaining wallet share
We are positive on TCS's growth outlook even after earnings surprises over the
past several quarters. Given its increasing revenue wallet share, we expect
revenue growth to remain strong in the coming years. We initiate with a Buy.
Despite increasing base, revenue growth to remain strong
We believe the opportunity for renewal of US$174bn of large IT/BPO outsourcing deals
within the next two years will keep TCS’s revenue visibility high given TCS’s increasing
revenue wallet share from large deals. We also believe TCS’s revenue growth will remain
strong despite its high base and consistent outperformance in recent quarters, thanks to the
company’s higher revenue weighting toward high-growth verticals including BFSI (banking,
financial services and insurance) and retail (combined contribution of more than 55% of
revenue), increasing wallet share in emerging verticals (where we believe global sourcing
potential is higher) and improving client mining. Given all of the above, we expect TCS’s
USD revenues to show at a 23% CAGR for FY11-13F.
Any margin decline from here on looks unlikely to be sharp
We believe TCS has done a creditable job in improving EBITDA margins by a significant
630bp over the past 10 quarters. This has resulted in positive earnings surprises. In this
transition, most of the headroom in margin levers (including utilisation, offshoring, SG&A
leverage) has been utilised at optimum levels. However, with strong volume visibility, we
expect economies of scale to continue and we expect lower-margin downside vs some of
TCS’s peers in our coverage universe.
Initiate at Buy
We are optimistic about TCS’s growth outlook, given its increasing revenue wallet share from
large deals and client mining. Despite several quarters of positive earnings surprises, we
expect revenue growth to remain strong. We also believe margin downside from here on is
likely to be lower than that of some of its peers. We initiate coverage at Buy, with a target
price of Rs1,350 (upside potential of 14%) implying a target PE multiple of about 22x FY13F
vs an EPS CAGR of 18% for FY11-13F. Our target price implies a target EV/EBITDA multiple
of about 15x FY13F (vs an EBITDA CAGR of 20% for FY11-13F).
The basics
Catalysts for share price performance
We expect the key near-term catalysts to be:
Higher growth in outsourcing and offshoring as TCS’s clients finalise their CY11 IT budgets.
We expect TCS to gain the most vs its peers considering its large focus on high-growth
verticals, including BFSI and retail. TCS’s increasing revenue wallet share in emerging
verticals should keep revenue growth momentum high.
Cognizant’s guidance for CY11 (in February 2011). Infosys’s guidance for FY12F in April
2011. While building in its typical conservatism, we expect Infosys to take a more confident
stance on FY12 guidance.
The renewal opportunity for large outsourcing deals worth US$174bn over the next eight
quarters beginning with 4QCY10 (about US$90bn in renewals due in 4QCY10-3QCY11F). We
expect TCS to be a major winner, based on its increasing wallet share of large deals.
Higher growth in discretionary spend for the IT industry would add to revenue growth
momentum in FY12F vs FY11F for TCS (discretionary services contributes more than 40% of
TCS’s revenues).
A pick-up in demand momentum from Europe (in addition to continuing momentum from the
US), with expected higher outsourcing, should benefit TCS, considering its large base in
Europe vs its peers and its higher traction in public sector verticals in the UK.
Earnings momentum
With TCS’s 1) increasing wallet share in large deals, 2) higher revenue weighting on highgrowth
verticals including BFSI and retail (combined contribution of more than 55% of
revenues) and 3) increasing wallet share in emerging verticals, we believe its revenue growth
will remain strong in the next few years.
We believe TCS has done a creditable job in improving its EBITDA margins by a significant
630bp over the past 10 quarters. In this transition, most of the headroom in margin levers has
been used at optimum levels. However, with strong volume visibility, we expect economies of
scale to continue and we expect lower margin downside vs some of TCS’s peers we cover.
Our forecasts assume USD revenue, INR EBITDA and INR EPS CAGRs of 23%, 20% and
18%, respectively, for FY11-13.
Valuation and target price
We value TCS based on a PE multiple derived as a premium to Infosys (which we take as our
industry benchmark). We initiate with a Buy rating and target price of Rs1,350, implying target PE
multiple of 22x FY13F and a target EV/EBITDA multiple of about 15x FY13F. Our target PE
multiple is at a premium of about 7% to Infosys’s target PE multiple (vs the current valuation
premium of 12-13% for FY12F and FY13F), which we believe is fair considering TCS’s consistent
increase in revenue wallet share (even on a high base), as well as significant improvement in
margins vs peers (including Infosys) despite similar macro parameters driving each peer’s
revenue and earnings growth.
How we differ from consensus
Our FY12 and FY13 EPS forecasts are almost in line with Bloomberg consensus. Given our
expectations of strong revenue momentum, we do not rule out further upside.
Risks to central scenario
Any further deterioration in the macro environment in western economies, as the US and
Europe contribute more than 80% of TCS’s revenues.
A sharp appreciation of INR vs the USD would be significantly negative for revenues and
hence margins/EPS, as would a sharp depreciation in EUR, GBP and AUD vs the USD.
Fiscal austerity and resulting protectionism measures in western economies.
Expect robust revenue growth to continue
With increasing revenue wallet share, as well as significant opportunity from renewal of
large outsourcing deals (due in the eight quarters beginning in 4QCY10), we expect TCS to
continue to report strong revenue growth in the coming years.
We believe the opportunity from the renewal of large outsourcing deals worth US$174bn in the
next two years will keep revenue visibility high given TCS’s increasing revenue wallet share from
large deals. We also believe revenue growth will remain strong in the coming years, given the
company’s higher revenue weighting in high-growth verticals, including BFSI and retail (combined
contribution of more than 55% of revenues), increasing revenue wallet share in emerging verticals
(where global sourcing potential is higher) and improving client mining. This is despite its high
base and consistent revenue growth outperformance in recent quarters. Given the above drivers,
we expect TCS’s USD revenues to show a 23% CAGR for FY11-13.
High base having no impact on growth
Despite the high base, TCS has outperformed all Indian IT large-cap peers in revenue terms, as
well as in terms of margins post 1QFY10A (the quarter that first showed signs of stabilisation of
recessionary pressure). We believe this was largely due to the company’s: 1) increasing
dominance in BFSI, 2) increasing traction in emerging verticals (which are non-traditional verticals
excluding BFSI, manufacturing, retail, telecom/high-tech, etc), 3) mining the existing client base,
and 4) higher growth through non-linear initiatives, including products.
The preceding table indicates that TCS is poised to gain more than its peers from the US$174bn
worth of large outsourcing contracts expected to be up for renewal over the next two years. With
an increasing trend of deal restructuring/renewals within ADM (application development and
maintenance) combined with IMS (infrastructure management services), we believe TCS will be a
preferred vendor, given its 3QFY11A annualised revenues already exceed US$4.5bn in these two
services alone. However, with other players, including HCL Tech, catching up, we believe these
services are likely to be highly competitive going forward.
TCS focus on client mining has improved significantly
We believe that one of the reasons for TCS’s recent revenue growth outperformance is its
increasing focus on client mining. Despite Infosys continuing to lead in client mining, TCS
registered 6.1% compounded qoq growth in average revenue per active client over 1QFY10-
3QFY11 (the highest among the top three India IT large caps). With TCS’s dominance in most
traditional services, we believe this focus will lead to further stickiness with clients.
Infosys and TCS derive the highest revenues from high-growth verticals (BFSI, retail)
Our macro analysis indicates that BFSI, retail and, to some extent, manufacturing are likely to
provide improved growth opportunities even beyond CY10 for Indian IT, with most global
companies operating in these verticals likely to register high-single-digit to double-digit growth in
revenue/earnings in CY11-12F (see Chart 4, 5 and 8 in our sector note). Given TCS’s highest
revenue contribution is from these verticals, we believe its deal pipeline is likely to continue to be
robust.
All-around positioning
Despite increasing revenue wallet share in large traditional verticals including BFSI, TCS has also
been gaining wallet share in emerging verticals (emerging verticals include energy/utilities,
media/publishing/entertainment, healthcare, life sciences, services and others), as shown in Table
5. Given the significant opportunity for global outsourcing within emerging verticals, we believe
TCS’s wallet share in large deal wins is likely to remain robust. This makes us more confident in
our estimates for continued revenue growth momentum beyond FY11.
Margin decline unlikely to be sharp
Despite limited headroom to improve margins going forward, we expect no major margin
decline and expect TCS’s margin performance to exceed Wipro’s even in the next few
years.
We believe TCS has done a creditable job in improving its EBITDA margins by a significant 630bp
over the past 10 quarters, a big driver for the earnings surprises over the past several quarters.
During this industry leading margin improvement over the last 10 quarters, most of the headroom
in margin levers (including utilisation, offshoring, SG&A leverage) has been utilised at optimum
levels. We agree that a material portion of the increase in the offshore revenue contribution over
1QFY09-3QFY11 was due to the acquisition of TCS e-Serve (effective 4QFY09). However,
excluding this, improvement in organic offshoring is also steep at more than 700bp.
We believe Infosys’s margin headroom is better than that of its peers. However, comparing TCS
and Wipro, we believe TCS’s high revenue growth visibility will continue to drive relatively high
economies of scale and, thus, we expect better earnings growth in TCS vs Wipro going forward.
Initiating coverage at Buy
We initiate on TCS with a Buy rating as we expect its industry-leading revenue growth to
continue in the next few years and we see better earnings visibility than at some of its
peers. TCS is our second pick after Infosys among our top three large caps.
The revenue wallet share of the Indian large-cap IT companies has been gaining increasing
weight in their respective fair value multiples and the resulting premium or discount to peers, as
they all share macro drivers for growth and have a high revenue base. We expect TCS to trade at
a slight premium to Infosys for the foreseeable future because of its consistent gains in revenue
wallet share (even from a high base) and its significant catch-up to near Infosys’s EBITDA
margins (especially in its international business, which comprises about 91% of its revenues, vs
up to 98% for Infosys). We believe TCS’s revenue growth momentum will continue in the coming
years and we cannot rule out upgrades to our growth estimates.
Hence, we initiate coverage with a Buy rating and a target price of Rs1,350 implying a target PE
multiple of 22x FY13F (vs an EPS CAGR of 18% over FY11-13F) and a target EV/EBITDA
multiple of about 15x FY13F (vs an EBITDA CAGR of about 20% for FY11-13F). Our target PE
multiple is at a premium of about 7% to our target for Infosys (vs the current valuation premium of
12-13% for FY12F and FY13F), which we believe is fair considering TCS’s consistent growth in
revenue wallet share and significant improvement in margins vs peers (including Infosys) despite
similar macro parameters driving each peer’s revenue and earnings growth.
Management team
Tata Group holds a 74.1% equity stake in TCS, which is managed professionally. Mr N
Chandrasekaran, the CEO and Managing Director has been with TCS for more than 20 years
and, during his time in charge, the company has posted industry-leading revenue growth rates
with a compounded qoq USD revenues growth rate of about 7% from 3QFY10 to 3QFY11. The
company also has a strong second line of senior managers heading various business segments.
TCS is India’s leading IT services company, with a 3QFY11 annualised revenue run rate
exceeding US$8.5bn. It has been consistent in dividend payment, with a payout ratio of 25-30%
for FY08-09. For FY10, in addition to a final dividend payout, TCS announced a special dividend,
resulting in a total dividend payout of about 57% for FY10.
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