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Our recent meeting with TCS CFO indicates that TCS is not witnessing any negative impact
from macro headwinds on demand yet. However high forex hedges with sharp rupee
depreciation may limit the continuing quarterly EPS beat in coming quarters if current spot
rates continue.
No impact from recently increased macro headwinds yet
TCS continues to witness stable demand trends despite recently increased macro
headwinds. In line with Indian peers, it has not witnessed any deal cancellation/delays
yet.
TCS has not changed its recruitment plans with likely gross employee addition of 17000-
20000 in 2QFY12 (11988 in 1QFY12) and around 60000 in FY12.
While earlier pricing re-negotiation (largely based on cost of living adjustment) may
provide some tailwind, TCS is not expecting any major change in reported pricing in
coming quarters (with change in revenue mix). TCS expects stable pricing environment
going forward.
TCS expects more clarity on CY12 IT budgets by the end of CY11. However we believe
that macro headwinds may lead to cautious CY12 IT budgets with more short term
spending commitments rather than any major long term commitments from clients. The
impact may be higher in BFSI given that the BFSI sector is again in the centre stage of
the ongoing financial crisis, with slowing growth in developed economies, the sovereign
debt crisis in Europe (entailing write-offs on bond assets), and major potential lawsuits on
mortgage assets.
High forex gains may not continue
The management re-iterated that the 2QFY12 USD revenue growth is likely to be lower than
1QFY12 reported growth of 7.5% qoq (versus our and consensus current expectation of 6-7%
growth).
Regarding margins for 2QFY12, TCS continues to expect headwind from promotions and
tailwind from currency. We expect margins in 2QFY12 to improve qoq with expected high
volume growth and favourable currency movements.
Amongst Indian peers, TCS had sizable outstanding forex hedges at the end of 1QFY12. TCS
has around US$1.7bn worth of outstanding revenue hedges (with US$1.1bn to be matured in
2QFY12 and balance beyond FY12), equivalent to 3-4 months of net inflow. Most of the
revenues hedges are taken as range options with lower end of the hedge rate at slightly
below Rs45 with participation in rupee depreciation beyond Rs45 till upper range which is not
disclosed by TCS. However, notably most of the hedges due in 2QFY12 are maturing in later
part of 2QFY12 wherein Indian rupee started depreciating versus USD sharply.
Besides above mentioned hedge cover, TCS also has around US$1.5bn worth of nondesignated
hedges at the end of 1QFY12 where quarterly mark to market (MTM) entry is
passed through income statement. Notably last mark to market rate at 1QFY12 end was
Rs44.70 versus current sport rate of around Rs48. Therefore we expect most of the balance
sheet translation gain to get minimised with likely MTM losses on non-designated hedges in
2QFY12.
Considering above two points, we believe that forex income below the EBITDA line is likely to
reduce significantly in 2QFY12 versus reported forex gain of about Rs800-900mn in 1QFY12.
Secondly, our interaction also indicated that TCS is almost fully hedged for 3QFY12 with
average strike rate of Rs46.5 versus current spot rate of around Rs48. Therefore if current
spot rate continues in 3QFY12, we expect material impact on forex income even in 3QFY12
for TCS.
TCS's outstanding hedges has been volatile with changes in hedge positions and coverage in
the past quarters.
Amongst peers, given low hedge positions of Infosys and HCL Tech (equivalent to 2-3
months of net inflow), we expect the impact on forex income through hedges to be lower than
TCS in coming quarters. Even in case of Wipro, despite higher outstanding hedges, maturity
of the hedge cover is spanning from 2-4 quarters to around 2 years which will reduce the
impact, if any, in immediate quarters. However, we await more clarity from management
regarding this.
Our view
In this state of increased macro uncertainty, we prefer stocks with relatively low valuations,
more revenue diversity and higher flexibility in managing margins. In our view, TCS does not
offer any favourable risk-reward at current valuations given its relatively low vertical
diversification beyond BFSI, low headroom in most of its margin levers versus peers and its
relative stock outperformance year to date.
We maintain Hold.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Our recent meeting with TCS CFO indicates that TCS is not witnessing any negative impact
from macro headwinds on demand yet. However high forex hedges with sharp rupee
depreciation may limit the continuing quarterly EPS beat in coming quarters if current spot
rates continue.
No impact from recently increased macro headwinds yet
TCS continues to witness stable demand trends despite recently increased macro
headwinds. In line with Indian peers, it has not witnessed any deal cancellation/delays
yet.
TCS has not changed its recruitment plans with likely gross employee addition of 17000-
20000 in 2QFY12 (11988 in 1QFY12) and around 60000 in FY12.
While earlier pricing re-negotiation (largely based on cost of living adjustment) may
provide some tailwind, TCS is not expecting any major change in reported pricing in
coming quarters (with change in revenue mix). TCS expects stable pricing environment
going forward.
TCS expects more clarity on CY12 IT budgets by the end of CY11. However we believe
that macro headwinds may lead to cautious CY12 IT budgets with more short term
spending commitments rather than any major long term commitments from clients. The
impact may be higher in BFSI given that the BFSI sector is again in the centre stage of
the ongoing financial crisis, with slowing growth in developed economies, the sovereign
debt crisis in Europe (entailing write-offs on bond assets), and major potential lawsuits on
mortgage assets.
High forex gains may not continue
The management re-iterated that the 2QFY12 USD revenue growth is likely to be lower than
1QFY12 reported growth of 7.5% qoq (versus our and consensus current expectation of 6-7%
growth).
Regarding margins for 2QFY12, TCS continues to expect headwind from promotions and
tailwind from currency. We expect margins in 2QFY12 to improve qoq with expected high
volume growth and favourable currency movements.
Amongst Indian peers, TCS had sizable outstanding forex hedges at the end of 1QFY12. TCS
has around US$1.7bn worth of outstanding revenue hedges (with US$1.1bn to be matured in
2QFY12 and balance beyond FY12), equivalent to 3-4 months of net inflow. Most of the
revenues hedges are taken as range options with lower end of the hedge rate at slightly
below Rs45 with participation in rupee depreciation beyond Rs45 till upper range which is not
disclosed by TCS. However, notably most of the hedges due in 2QFY12 are maturing in later
part of 2QFY12 wherein Indian rupee started depreciating versus USD sharply.
Besides above mentioned hedge cover, TCS also has around US$1.5bn worth of nondesignated
hedges at the end of 1QFY12 where quarterly mark to market (MTM) entry is
passed through income statement. Notably last mark to market rate at 1QFY12 end was
Rs44.70 versus current sport rate of around Rs48. Therefore we expect most of the balance
sheet translation gain to get minimised with likely MTM losses on non-designated hedges in
2QFY12.
Considering above two points, we believe that forex income below the EBITDA line is likely to
reduce significantly in 2QFY12 versus reported forex gain of about Rs800-900mn in 1QFY12.
Secondly, our interaction also indicated that TCS is almost fully hedged for 3QFY12 with
average strike rate of Rs46.5 versus current spot rate of around Rs48. Therefore if current
spot rate continues in 3QFY12, we expect material impact on forex income even in 3QFY12
for TCS.
TCS's outstanding hedges has been volatile with changes in hedge positions and coverage in
the past quarters.
Amongst peers, given low hedge positions of Infosys and HCL Tech (equivalent to 2-3
months of net inflow), we expect the impact on forex income through hedges to be lower than
TCS in coming quarters. Even in case of Wipro, despite higher outstanding hedges, maturity
of the hedge cover is spanning from 2-4 quarters to around 2 years which will reduce the
impact, if any, in immediate quarters. However, we await more clarity from management
regarding this.
Our view
In this state of increased macro uncertainty, we prefer stocks with relatively low valuations,
more revenue diversity and higher flexibility in managing margins. In our view, TCS does not
offer any favourable risk-reward at current valuations given its relatively low vertical
diversification beyond BFSI, low headroom in most of its margin levers versus peers and its
relative stock outperformance year to date.
We maintain Hold.
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