Hold rating on Tata Consultancy Services shares: Edelweiss

Updated: Oct 21 2013, 17:09pm hrs
Tata Consultancy Services (TCS) Q2FY14 revenues at $3,337m, 5.4% quarter-on-quarter growth, were marginally above Street estimate of 5.1% growth. Organic growth stood at 4.2% while ALTI (French firm acquired) contributed 1.2% to growth. Ebidta margin at 31.6%, surged 300 bps q-o-q. Revenue growth was driven by a robust volume growth of 7.3%.

However, this was partially offset by 94bps realisation decline and cross currency (CC) impact of 60bps. We maintain our stance of TCS outperforming its peers in revenue growth and hence maintain our revenue growth estimate (in USD) of 18% for FY14 and 15% for FY15e. We would like to, however, note that the growth gap between TCS and peers like Infosys and Wipro will reduce gradually. Revision of our $/R assumption to R62/60 from R58/56 for FY14/15 respectively leads to 14.7%/16.8% revision in our FY14e/15e EPS estimates. We maintain Hold with a revised target price of R1,982.

No positive surprise: TCS has reported robust q-o-q volume growth in H1FY14 (6.1% and 7.3% in Q1 and Q2, respectively), however realisations have dipped by 160bps and 94 bps q-o-q during the same time-frame. Currency drove margin expansion of 300bps q-o-q versus expectation of 250bps. The quarter saw an all-round performance with all the verticals growing sequentially. TCS maintained that it has a robust pipeline both in annuity and discretionary spend. Traction in SMAC (social, mobile, analytics & cloud) technologies continues to increase with clients diverting discretionary spend to these segments. Deal traction continued and it won eight deals during the quarter with two each in BFSI (banking, financial services and insurance) and telecom.

Key highlights

*In USD terms, revenue grew 5.4% q-o-q (1.2% from ALTI acquisition) to $3,337m, below our estimate of $3,355m. Volume growth came in at 7.3% q-o-q. In INR terms, revenue at R209.8bn was up 16.6% q-o-q and 34.3% y-o-y.

*Gross profit for the quarter stood at R102.8bn, up 20.9% q-o-q. Gross margin was 49.0%, up 180bps q-o-q.

*Operating margin: Ebit rose 310bps q-o-q to 30.1% largely led by currency benefits.

*Net income: Net income of R47.0 bn was up 23.9% q-o-q. Net profit margin rose 130bps to 22.4%.

*Clients data: The number of $1m clients increased by 30 to 687; there was an increase in $5m (9), $10m (8) and $20m (i) client brackets over the previous quarter. The company also added three clients in the $100m category. Deal traction continued to be strong as it won eight deals during the quarter.

*Hiring momentum continues: Gross addition stood at 17,362 on the back of 10,611 in the previous quarter, while net addition was 7,664. Total headcount stood at 2,85,250. Attrition (LTMlast twelve months) in IT services rose to 9.9% from 9.6% in the previous quarter.

*Utilisation inches up: Utilisation rate (excluding trainees) inched up 70bps q-o-q to 83.4%; including trainees, it was up 250bps q-o-q to 75.0%.

*Geography split: North America, Continental Europe and UK reported sequential growth of 3.7%, 19.3% and 7.3% q-o-q, respectively. APAC (Asia-Pacific) grew by 8.5% while India declined 4.3% q-o-q. MEA (Middle-East & Africa) and Latin America grew 0.4% and 1.0% q-o-q respectively.

*All verticals post growth: Growth in life sciences, BFSI and manufacturing surged 9.3%, 5.7% and 5.4% q-o-q, respectively. Retail and hi-tech grew 4.7% and 3.5% q-o-q, respectively, while transportation grew 5.4% q-o-q.

*Enterprise solutions, engineering services, assurance services spur growth: Growth during the quarter was driven by enterprise solutions, engineering services and assurance services, which surged 7.5%, 5.4% and 10.6% q-o-q, respectively. ADM (application development and maintenance) grew 3.9% q-o-q while infrastructure services grew 4.5% q-o-q. BPO and asset leveraged solutions grew 5.4% and 13.8% q-o-q, respectively. Global consulting declined 0.6% q-o-q on the back of strong growth of 17.5% in previous quarter.

Outlook and valuationsexcellent but expensive: While we expect TCS to be the key beneficiary of the uptick in demand environment and favour it owing to its strong execution, but the sharp run-up in the stock during the last three months (up 35%) makes the stock expensive at current valuations (20.1x FY15e EPS). While we maintain our revenue growth estimates for FY14 and FY15 due to our positive stance on growth and execution capabilities, revision of our USD/INR assumption to R62/60 from R58/56 for FY14/15 respectively leads to 14.7%/ 16.8% revision in our FY14E/15e EPS estimates. We maintain Hold/SP with a revised TP (target price) of R1,982.