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Tata Consultancy Services Overweight
TCS.BO, TCS IN
Reasserting its supremacy yet again with a strong
quarter; reiterate OW
TCS reasserted its superiority in the Indian IT sector once again with an excellent,
well-rounded quarter. The twin highlights of the quarter, in our view, were: (a)
the 7.5% revenue growth Q/Q (overall and in Europe) – overcoming concerns
that the very tough macro-environment may affect offshore IT spending
especially in Europe, (b) the all-roundedness of growth. TCS is demonstrating
that it is continually raising the bar in the sector and extending its lead in
indefatigable fashion. However, already high expectations may limit operating EPS
upgrades in the Street despite such a good quarter.
Management commentary is positive notwithstanding stiff difficulties in the
macro-environment. TCS reiterates strong demand (even for discretionary
projects) and sees a robust pipeline even in Europe. This is in contrast to the
commentary of Infosys that it is witnessing some slowness in decision-making on
discretionary spending – which supports our contention that growth issues at Infosys
are largely company-specific. Also, this echoes our view that enterprise IT spending
geared toward cost rationalization, streamlining and restructuring of business
processes and even for growth-oriented initiatives is still healthy.
Any immediate concern(s) on TCS that the investor might perceive? The
investor might point out that for the quarter, net employee addition was just over
1.5% Q/Q. Coupled with red-hot utilization at over 83% (ex-trainees), investors
could ask whether supply is rather tight to capitalize fully on growth opportunities
in 2QFY12. We believe, however, that TCS has the best execution engine in the
industry, demonstrating continued ability to realize growth despite running on tight
utilization. Also, laterals (readily deployable resources) can be hired in short order
and trainees recruited in 1QFY12 could come on stream to contribute to billing in
2QFY12. In short, we do not see this as a concern.
Reiterate OW and top pick status. TCS has been among our top picks for a while.
The TCS earnings story has been one of continual & significant EPS upgrades over
the past 6-8 quarters. This has been a structural call for us (versus Infosys rated
Neutral) for over a year. Performance of the two in 1QFY12 suggests that we may
still not be near the end of the relative re-rerating story of TCS vis-à-vis Infosys.
Indeed, TCS is now recognized as the absolute valuation benchmark in the sector.
We value TCS at 22x FY13E P/E (a 10% premium to our ascribed valuation for
Infosys, we expect this premium to sustain).
1QFY12 Highlights
1QFY12 revenues came in at $2.41 billion, increasing 7.5% Q/Q (in $ terms)
and up 6.3% in INR terms (Rs.108.0 billion). Impressive volume growth of
7.4% drove the revenue growth, while pricing was modestly negative.
Notably, top-line growth from international markets (exports) was healthy 6.9%
Q/Q (in USD terms). India-revenue growth was very strong at 13.6% (in US$
terms). Exchange rate movement was modestly positive for revenue growth.
Pricing was slightly negative for 1QFY12 and caused 50 bps negative growth for
the quarter. However, there was a mix shift toward emerging geographies where
pricing tends to be lower than traditional markets, which explains the slight
decline in pricing. Management suggested that a robust growth environment is
likely to drive pricing expansion some time during the fiscal year.
Table 2: Revenue growth break-up by drivers
Revenue growth contribution
Factor 1QFY12
Volume Growth +7.5%
Forex +0.1%
Pricing -0.5%
Offshore Leverage -0.8%
INR Growth +6.3%
Source: Company reports
TCS added 24 clients during the quarter. Net increase in million dollar clients
was 15, while the company added 6 and 2 accounts to $50 mn and $100 mn
bucket, respectively. TCS won 10 large deals during the quarter including about
5 in the Americas, 3 from Europe, and 2 from other geographies.
All industry verticals (including Telecom) exhibited strong growth except
Energy and Utilities, which declined 11.2% Q/Q. Revenues from Hi-Tech,
Telecom and Retail exhibited double digit revenue growth rate of 15.4%, 14.3%
and 11.3% , respectively, on Q/Q basis, which we believe is very impressive.
Particularly, Telecom is perceived to be going through structural weakness
and double digit revenue growth in this vertical exhibits strong positioning
of the company. Manufacturing witnessed strong revenue growth of 8.9% Q/Q,
while BFSI (the largest vertical for TCS) grew 5.8% sequentially. Healthcare
and Transportation Q/Q revenue growth was slightly muted at 5.5% and 2.0%.
Proportion of fixed price contracts increased modestly to 49.7%, from 49.5%
last quarter, a historically high level.
TCS reported a net employee addition of 3,576 during the quarter, while gross
addition was 11,988, including 7,752 lateral hires. Management guided to hire
60,000 in FY12 and expects to hire 17,000-20,000 employees (gross) in
2QFY12.
Quarterly annualized attrition decreases to 16.9% in 1QFY12 increasing
modestly from16.3% in 4QFY11. On a LTM basis also, attrition increased
modestly from 14.4% to 14.8%. However, we do not believe it is concerning as
employees tend to switch jobs in 1QFY12 after wage hikes.
Utilization (excluding trainees) increased 80 bps from 82.4% to 83.2%, close to
the all time high of 83.8% (last year). Utilization including trainees was up 110
bps from 75.1% to 76.2%. Management reiterated that the company would
target to operate at 82%-84% (ex trainees) utilization rate. The strong
utilization is in agreement with our view that the 'new normal' for
utilization should be higher than the historical average.
All geographies exhibited strong revenue growth for TCS in 1QFY12. MEA
(Middle-East and Africa) and India revenues (in US$ terms) grew double digit at
18.2% and 13.6% Q/Q, respectively. Encouragingly, Continental Europe and
UK witnessed solid sequential revenue growth of 7.5% and 6.1%
respectively despite macro concerns. Americas’ (the US, Canada and Latin
America) revenues grew 6.3% Q/Q, while Asia-Pacific region (ex India and
MEA) witnessed sequential revenue growth of 9.0% in 1QFY12.
In terms of service lines, Global Consulting (+12.6% Q/Q), Enterprise
solutions (+7.5% Q/Q) and Business Intelligence (+7.5% Q/Q) (in US$
terms) witnessed strong revenue growth in 1QFY12 primarily driven by
increased client spending on discretionary projects. Infrastructure Services
and Testing Services each exhibited double digit sequential revenue growth of
slightly above 12%. Application Development and Management (+7.7% Q/Q)
also reported strong revenue growth, while Engineering and Industrial Services
(3.0%) and BPO (1.0%) businesses registered slightly muted growth on a Q/Q
basis.
EBIT margins declined 210 bps to 26.2% from 28.3% in 4QFY11 (as per IFRS).
Margins remained modestly below our and consensus estimate of 26.8% and
26.7%, respectively. Gross profit margins declined 140 bps to 44.3%.
Tax rate for Q1 increased meaningfully to 22.7% (21.8% in Q4). The increase
was primarily due to expiry of STPI exemptions.
DSO stood at 83 days, increasing modestly from 80 days in 4QFY11. TCS had
invested funds of Rs.105.2 billion at the end of 1QFY12 compared to Rs.93.6
billion last quarter.
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