Tata Consultancy Services (TCS) reported first quarter 2010-11 revenue of $1,794 million, which implies 6.41% sequential growth. Revenue growth in the first quarter in constant currency terms was higher at 7.3%?the difference is on account of the depreciation of the sterling and euro against the US dollar. The management commented that the deal pipeline was very robust and discretionary spending by clients was increasing. The proportion of deals in the pipeline that was of discretionary nature had gone up, according to the management. TCS won ten large deals [all from verticals other than BFSI (banking, financial services and insurance)] in first quarter and is chasing another 15 large deals. Also, the management expects to see an increase in pricing by the year end.
Strong volume growth: TCS recorded a solid volume growth of 8.1% sequentially in Q1, driven by broad-based growth across verticals and geographies. Four of nine verticals, including telecom?which had seen sharp decline in the recent past?registered double-digit growth in the quarter. BFSI (4.3% QoQ), telecom (10.8% QoQ) and retail (7.4% QoQ) contributed the most towards incremental growth. Among geographies, growth was seen in Europe?both in the UK (8.1%) and in continental Europe (1.2%). The US (8.4% QoQ) contributed to the bulk of incremental growth.
Margin decline limited: Ebitda margins surprised with only a 60 basis points decline sequentially despite a 10% increase in salary costs. A reduction in bad debts and provisions and in R&D expenses helped partly offset the impact of wage hikes and cross- currency movement. The management appeared confident that they it could maintain Ebit margins above 27%. Ebit margin decline was lower at 36 basis points due to 3.3% QoQ reduction in depreciation.
Utilisation increases: Utilisation improved 50 basis points QoQ to 74.8% on account of strong volume growth and lower net addition sequentially. Net additions were 3,271 in Q1 compared with 10,775 in the previous quarter. Attrition for TCS (standalone) increased from 13.9% to 17.5% sequentially. Net profit fell by 4.5% sequentially in Q1 to Rs 1,844 crore on account of a higher tax rate.
We have slightly raised our revenue growth (in dollars) estimate in FY11 to 23% from 22% on the back of the strong volume growth seen in Q1. Our margin estimates are higher in FY11, again on account of the better-than-expected margin performance in Q1. We have increased the tax rate forecast for FY12 to 24% in line with management guidance. As a result of these changes, our EPS (earnings per share) estimates for FY11 and FY12 increase by 7.8% and 3.5%, respectively.
Reiterate Neutral: We maintain a Neutral rating on TCS as we see limited upside in the stock. We believe there is less likelihood of a positive surprise in volume growth or margins, going forward. Our price target increases to Rs 890 from Rs 860, primarily on account of higher near term margin estimates.
Our revised 12-month price target of Rs 890 is based on a DCF (discounted cash flow) calculation, assuming a terminal growth rate of 5% and an 11% cost of equity in rupee terms.
Downside risks include a sharp appreciation of the rupee against the US dollar and a double-dip recession in the US. Upside risks include an increase in discretionary spending by clients, fuelled by a higher-than-expected economic growth in the US and Europe.