TCS:: 2QFY11 superlative on all counts:: Sept 2010 qtr:: JPMorgan

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Tata Consultancy Services
Overweight
TCS.BO, TCS IN
2QFY11 superlative on all counts - emergence of new
P/E leadership in the Indian IT industry seen



• New P/E leadership in the Indian IT industry: TCS' superlative 2QFY11 results
confirm our long-held thesis that it is ready to take P/E leadership in the sector at a
time when the sector is experiencing exceptional demand. With industry-leading
revenue growth, despite being more than 30% larger in size than Infosys (its closest
peer), ever-improving margin performance and most of all admirable consistency
over the past six quarters, we believe TCS decisively demonstrates that it is wellpoised
to command premium valuations in the industry.
Robust revenue growth + Margin expansion = Bottom-line much beyond estimate
• Revenue grows 11% sequentially, crossing US$2bn and this is entirely volumedriven:
In a quarter of incremental revenue increase of US$210 mn Q/Q, almost all
verticals witnessed healthy growth, with energy and utilities growing at near-50%
Q/Q (off a small base). Even relatively troubled verticals such as manufacturing
have registered double-digit sequential growth. TCS has entirely depended on
volumes to drive revenues. In our view, volume growth is a better predictor of
sustainability of demand than business mix-led pricing improvement.
• Operating margins hit all-time high, on parity with Infosys on a like-for-like
basis: It surprises us that even in a quarter in which promotion-linked wage hikes
and 150% variable wage were incurred, impacting margins by 166 bps, TCS was
able to raise EBIT margins 90 bps Q/Q to 28%. This represents the culmination of a
process of relentless improvement in operating margins, up by 600bps since
Q1FY09. EBIT margins now stand within 220 bps of Infosys and adjusted for TCS'
exposure to the India market (10% of revenues), where margins are much lower, we
estimate margin parity on the overseas (export) business with Infosys.
• Maintaining the traditional offshore leverage despite high onsite demand: This
attests to TCS’s exceptional strength in fixed price (unequalled in the industry, in our
view) which enables the company to maintain high offshore leverage (same level as
in 1QFY11), despite being flush with project starts that originate onsite.
• Investment view: Likely to lead the sector on valuation, maintain OW with Sep-
11 PT of Rs1150. We roll over our target price from Mar-11 to Sep-11 and ascribe a
P/E multiple that represents a modest premium to Infosys. Yet again, we raise our
FY11E/12E EPS by 4%/5%. Notably, our EPS upgrade is revenue-led rather than
just margin-led. TCS remains our top pick among the large-caps and we
continue to recommend TCS (OW) over Infosys, believing it will return the
extra 5-7% return over what Infosys is likely to over a 12-month horizon.