TCS’ Q1FY13 results indicate flawless execution. The company has
been able to report growth across most verticals in a tough
environment. While revenue growth was in line with expectations,
EBIDTA margins were 100bp lower than our estimates and 50bp
lower than consensus. While revenue growth has been broad based,
we note that one mega deal won in November 2011 (effective March
2012) and one large telecom deal won last quarter contributed c.40%
of incremental revenues in Q1FY13. Management commentary was
positive indicating no change in stance v/s commentary of the past
six months. We continue to believe that current valuation does not
take into account client and vertical concentration risks. While we
don’t rule out a near term churn in favour of TCS from Infosys given
consistent underperformance by the latter, we find it increasingly
difficult to justify TCS’ valuation. Reiterate Neutral.
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Robust commentary lends comfort on numbers
In our recent initiation thematic, our key reason to remain Neutral on TCS was i)
expensive valuation and two: ii) concentration risks within BFSI. While the
valuation may remain expensive for an extended period of time given strong
execution versus peers in a tricky environment, we don’t think the current
valuation appropriately accounts for client and vertical concentration risks.
1. Friend’s Life and telco deal drove Q1 growth: Over 30% of incremental
revenues of $80m in Q1FY13 came from the Friends Life deal (which largely
explains why BFSI still looks strong – it accounts for $25m of the $50m
incremental revenues in BFSI), and a little over 10% came from ramp-up in
the telecom deal won last quarter. Our concern on concentration within
BFSI remains and the top client has added just $3m in incremental
revenues and top 10 accounts have added only $5m. TCS will need 3.8%
CQGR over the next three quarters to achieve 14% growth in FY13 which
could be tall ask given its high base.
2. Top client growth has moderated as expected: TCS saw its revenues from
its top client grow by 2% QoQ which was on expected lines. The top client
grew 24% CAGR in the last three years boosted by spending on IT.
However, those investments were completed in CY11 and growth going
forward could be muted. With five BFS clients among the top 10
accounting for ~32-38% of BFS revenues (vs. 29-31% for Infosys), we
believe client concentration risks are high. While peers have seen large
scale ramp downs TCS has not. In the current environment we believe the
possibility of such risks materializing is relatively high.
3. Margins expansion possibility limited: Operating margins came in 100bps
lower than expectations despite improvement in utilisation and favourable
currency. The levers to improve margins are limited in our view. Firstly,
price pressure will remain as Infosys has become aggressive on pricing and
secondly, in the last two years, “other costs” have contributed to a 246 bps
improvement in margins while all other costs have increased annually,
which only indicates that TCS is operating at optimal margins with limited
possibility to improve from here.
Valuation: 18.2x P/E multiple ignores risks
The current environment brings in significant demand volatility v/s earlier
years. In such an environment with BFSI taking centre stage and TCS’ exposure
to the vertical being the highest among peers, the current valuation is not
pricing in such risks. Moreover with growth rates among the top 10 clients
reducing, risks to growth are only incrementally higher. We expect TCS to
record 13% USD revenue growth in FY13 and earnings CAGR of 15% over FY12
to FY14. Stock trades at 18.2x FY13 earnings and we reiterate Neutral.
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