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We downgrade TCS to Hold. We expect relatively low upside hereon as TCS has
outperformed its peers since the last slowdown. We believe TCS's low vertical
diversification beyond BFSI (43% of revenues and where high macro challenges
have emerged) and low headroom in defending margins offers low risk-reward.
Low diversification beyond BFSI during turbulent times can be growth headwind
Despite TCS’s leading capability of winning large deals across verticals, we believe that its
high revenue contribution of 43% from BFSI (similar to the period prior to 2008/09 slowdown)
and its past consistent growth outperformance may face medium-term headwinds from the
global macroeconomic challenges that are emerging. With an increasing revenue base of
Indian IT large caps (TCS’s 1Q12F annualised run rate is USD9.6bn), vertical diversification
is of utmost importance. With likely higher outsourcing potential in other large verticals
including Manufacturing (including Technology) where TCS’s scale is not largely different
than peers, competitive pressures will continue, in our opinion.
Headroom in margin levers much lower than peers
We believe TCS has done a credible job in improving EBITDA 482bp over FY08-11, resulting
in positive earnings surprises and valuation re-rating. In this transition, most of the headroom
in margin levers (including utilisation, offshoring, SG&A leverage and fixed price projects)
has been utilised at optimum levels, in our opinion. Since the headroom in most margin
levers needs to be reasonably high during turbulent times such as these, we believe TCS
has little room to defend its margins.
Relative outperformance offers low risk-reward; downgrade to Hold
Given macro headwinds, we cut our forecasts of USD revenues by 6%/5% and INR EPS by
6% for FY13/14. We believe the revised PE valuation on FY12/13F does not offer favourable
risk-reward given TCS’s 16% outperformance to the BSE IT index ytd and given its low
revenue diversification/margin flexibility discussed earlier. We expect relatively low upside
hereon given its current valuation is near its five to six years’ mean of its one-year forward
PE while most peers are now trading below -1xSD to one-year forward PE. Hence we
downgrade TCS to Hold with a decreased target price of Rs1105 (from Rs1350), which
implies a PE of 19x FY13F, a 5% premium to our industry benchmark Infosys (down from our
earlier 10% premium to factor in increased earnings risk)
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
We downgrade TCS to Hold. We expect relatively low upside hereon as TCS has
outperformed its peers since the last slowdown. We believe TCS's low vertical
diversification beyond BFSI (43% of revenues and where high macro challenges
have emerged) and low headroom in defending margins offers low risk-reward.
Low diversification beyond BFSI during turbulent times can be growth headwind
Despite TCS’s leading capability of winning large deals across verticals, we believe that its
high revenue contribution of 43% from BFSI (similar to the period prior to 2008/09 slowdown)
and its past consistent growth outperformance may face medium-term headwinds from the
global macroeconomic challenges that are emerging. With an increasing revenue base of
Indian IT large caps (TCS’s 1Q12F annualised run rate is USD9.6bn), vertical diversification
is of utmost importance. With likely higher outsourcing potential in other large verticals
including Manufacturing (including Technology) where TCS’s scale is not largely different
than peers, competitive pressures will continue, in our opinion.
Headroom in margin levers much lower than peers
We believe TCS has done a credible job in improving EBITDA 482bp over FY08-11, resulting
in positive earnings surprises and valuation re-rating. In this transition, most of the headroom
in margin levers (including utilisation, offshoring, SG&A leverage and fixed price projects)
has been utilised at optimum levels, in our opinion. Since the headroom in most margin
levers needs to be reasonably high during turbulent times such as these, we believe TCS
has little room to defend its margins.
Relative outperformance offers low risk-reward; downgrade to Hold
Given macro headwinds, we cut our forecasts of USD revenues by 6%/5% and INR EPS by
6% for FY13/14. We believe the revised PE valuation on FY12/13F does not offer favourable
risk-reward given TCS’s 16% outperformance to the BSE IT index ytd and given its low
revenue diversification/margin flexibility discussed earlier. We expect relatively low upside
hereon given its current valuation is near its five to six years’ mean of its one-year forward
PE while most peers are now trading below -1xSD to one-year forward PE. Hence we
downgrade TCS to Hold with a decreased target price of Rs1105 (from Rs1350), which
implies a PE of 19x FY13F, a 5% premium to our industry benchmark Infosys (down from our
earlier 10% premium to factor in increased earnings risk)
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