Tata Consultancy Services: Nice and steady :: Kotak Securities

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TCS (TCS)
Technology
Nice and steady. TCS reported a solid quarter with revenue, margin and net income
ahead of our estimate. Volume growth was modest but not a surprise noting that
March is a seasonally weak quarter. FY2011 marks a strong year for TCS, where
revenues grew 29% and operating profit by 31%. We believe there are solid macro and
company-specific indicators that lend confidence to our above-consensus FY2012E rev.
growth (28%) and EPS of Rs54. Maintain BUY with an end-FY2013E TP of Rs1,350.

Solid but unexciting

4QFY11 performance was solid—revenues grew 4.7% qoq to US$2.24 bn, operating margin was

flat at 28% (50 bps higher than our estimate) despite lower utilization rate and adverse movement

in bad debt provision, while net income of Rs24 bn (+24.4% yoy, +3.1% qoq) was 1.7% ahead of

our estimate. Volume growth was a modest 2.9% qoq but not a surprise given that March is the

weakest quarter for IT companies.

Revenue growth was particularly strong in the manufacturing (+9% qoq), hi-tech (+13% qoq),

energy and utilities (+9% qoq) and travel and transportation (+20% qoq) verticals. BFSI (+3.3%

qoq) and telecom vertical (down 3.3% qoq) dragged. Growth was evenly distributed across

geographies – India was weak, however. Client metrics could have been better; TCS increased

relationship in US$20 mn and US$50 mn bucket but had a decline in the US$100 mn bucket.

Lead indicators positive for FY2012E

We believe that the Tier-1 IT companies will likely do well in FY2012E backed by (1) broad-based IT

spend revival, (2) strong large deal renewal cycle with greater participation and win rate for the

Indian names, (3) sustained market share gains for offshore pure-plays, (4) continued footprint

expansion across un/under-penetrated areas and (5) pricing uptick. TCS’ strong hiring numbers,

large deal announcements and strengthening leadership in scalable segments support our view.

We model 28.5% revenue growth for TCS for FY2012E, highest among the Tier-I India-listed

companies.

Broadly maintain estimates; reiterate BUY and target price

We maintain our higher-than-consensus revenue growth and earnings estimates (Rs54/63) for

FY2012/13E. Aggressive bets in future growth areas, incubation of new businesses, continued

dominance in areas of strength and outstanding all-round execution cement TCS’ industry leader

status. We maintain our target price on the stock at Rs1,350. Our implied target multiple on TCS is

at a marginal 5% premium to Infosys (10% adjusted for differences in depreciation policy);

substantial premium requires sustained outperformance on growth.

FY2011 round up—a strong year on every count

TCS has grown 29% in revenues in FY2011 to US$8.2 bn adding US$1.9 bn in absolute

revenues during the year. Growth was broad-based across all verticals, geographies and

service lines. More heartening was strengthening of leadership in core verticals viz: BFSI and

telecom and impressive growth in new service offerings. Growth was achieved without

sacrificing operational or financial control—utilization rates, relative control on attrition and

receivable collection cycle etc. demonstrate excellence in execution. The only criticism, if one

may, could be of relatively higher client concentration and lack of addition to clients in the

US$100 mn+ bucket. It is a bit of a surprise that TCS has a lower number of US$100 mn

and US$50 mn relationships than Infosys and is yet 35% larger in size.

Equally impressive was expansion in margins; this was achieved through strong control on

non-manpower costs (partly unsustainable) and keeping attrition under check. Free cash

flow generation at US$1.2 bn (47% of EBITDA) was solid.

Margin protection critical for strong growth in earnings in FY2012E

Increase in ETR in FY2012E will result in at least 3-4% gap in revenue and net income

growth for TCS in FY2012E. Margin protection is critical in FY2012E, in our view, to ensure

strong earnings growth. Some of the headwinds that TCS may face in FY2012E include (1)

250-300 bps from compensation revision, (2) likely increase in non-manpower costs; TCS

has done a good job in keeping a tight leash on some of these costs in FY2011. However

such a tight leash cannot sustain for long; growth will demand increase in discretionary

spend area of branding, marketing and non-discretionary areas of overseas travel and visas

and (3) utilization rate may dip given rising attrition. We believe that some of the headwinds

can be mitigated through (1) likely price improvement and pyramid expansion. We model 50

bps decline in operating margin for TCS in FY2012E.

Other highlights of 4QFY11 results and takeaways from management

commentary

􀁠 Revenue growth of 4.7% qoq was driven by volume growth of 2.9% qoq, sequential

pricing uptick of 80 bps and cross-currency benefits.

􀁠 Cross-currency benefits of 60 bps qoq mitigated margin pressure from onsite shift and

normalization in bad debt provisions, leading to flat EBIT margins for the quarter.

􀁠 Gross headcount addition for the quarter was 19,324 taking the total gross additions for

FY2011 to 69,685, substantially higher than the company’s initial guidance of 50,000.

􀁠 TCS has guided for a gross headcount addition of 60,000 for FY2012E and has made

37,396 campus offers.

􀁠 Attrition on an LTM basis was flat qoq at 14.4%; however, it declined 130 bps qoq to

15.8% on a quarterly annualized basis.

􀁠 The company indicated a stronger-than-ever deal pipeline, while also announcing 7 large

deal wins in the March 2011 quarter.

􀁠 TCS indicated 12-14% offshore, 2-4% onsite (developed markets), and 2-10% onsite

(emerging markets) wage hikes for FY2012E (including promotions).

􀁠 End-March 2011 hedge book stood at US$1.9 bn.