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1QFY12 results
1QFY12 marked TCS’ ascendancy at the top of the margin league tables in
IT Services. 26.2% EBIT margin for the quarter (though slightly below
expectations) came ahead of erstwhile margin leader Infosys (26.1%).
However, it was the strong top-line growth (+7.5%QQ/+34.5%YY)
which took centre-stage. While 2QFY12 could benefit from a favourable
1Q exit momentum, we fear that an unfavourable macro-environment
could limit TCS’ ability to meet/beat elevated street expectations in
2HFY12. Valuations at 21xMar'12 earnings are indicative of the street's
optimism on continuation of the current growth trajectory and this
remains the key challenge for the stock ahead. Underperform stays.
Strong revenue growth was the key highlight in 1QFY12
7.5%QQ up-tick in volumes was the key driver of TCS’ 7.5%QQ growth in $-
revenues. The key surprise was the strong growth in telecom vertical
(+14.3%QQ) c.f. declines seen at Infosys. Telcos in emerging markets are
driving this upswing at TCS. Note that Infosys’ telecom sector clientele is
largely limited to developed markets which is hurting their performance c.f.
TCS. Shift in business mix (towards emerging markets) impacted TCS’
realisations for the quarter, down 50bpsQQ. The management also
commented that some expected price hikes have not come through and while
they remain hopeful that 2HFY12 should be better for pricing, we would warn
against excessive optimism on this front.
Margins slightly below expectations
At 26.2%, TCS’ EBIT margins are now the highest in the IT Services industry.
It is indeed creditable that in a span of just over 2 years, TCS has closed the
600bps margin gap with Infosys. EBIT margins for the quarter however came
in slightly below street expectations and limited the operating profit beat.
Expectedly, wage hikes (250bpsQQ impact) impaired the margin
performance. Some benefits from operating leverage should drive margin uptick
in the quarters ahead. We are building in 27.3% margin for FY12. A beat
on net profit (Rs23.8bn, flattish QQ) for the quarter was facilitated by higher
interest income and forex gains of Rs796m (c.f. forex loss of Rs472m in 1Q).
Best credentials in the sector but already priced in the stock
A stable and decisive leadership and tailwinds from the current business
momentum should continue to drive TCS’ financial out-performance c.f.
peers. That said, we believe TCS’ YY growth trajectory has peaked and should
go down from 2QFY12. In our view, that will likely be an inflexion point for
the stock and valuations as well. We continue to believe that as a company,
TCS’ prospects remain the most solid (strong growth, good margins and
stable management) within the sector but the stock needs to contend with
high expectations, over-ownership and a deteriorating macro environment.
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