Sharp quarterly growth in India business
Largely inline quarter: TCS reported revenue of $3,040 million, Ebit (earnings before interest and taxes) margins of 26.5% and net profit of R36 billion. Constant currency growth was 4% aided by volume growth of 4.4%. India business reported a sharp growth of around 17% quarter-on-quarter, which helped overall growth rates. US (+2% q-o-q) and Europe (+0.4% q-o-q) were a little slow?likely explained by seasonal trends.
Margins steady: TCS delivered reasonably well on margins despite the one-off charge impacting margins by around 100bps (basis points) and currency impact of around 65 bps. Productivity resulted in an improvement of around 90bps q-o-q, which resulted in overall margins decline of around 73 bps q-o-q. The management indicated that it was confident of managing margins in a narrow band.
Deal flow, pipeline and pricing: TCS remains positive on FY14 growth rate?expects to grow faster than Nasscom and its FY13 reported growth rate. TCS signed 11 large deals in the quarter (vs. 7 in the last quarter) and indicated that the pipeline continues to be healthy and decisions are being taken. Pricing is stable at this point.
Other key points: (i) Wage hikes of average 7% for offshore employees while onsite wage hikes (developed markets) likely to be 2-4%; (ii) TCS has made offers to around 25k trainees and the overall hiring plan for FY14 is around 45k employees (vs. a gross hiring of around 70k in FY13); (iii) Expects telecom to start growing-?partly explained by a portfolio mix, where some ramp downs seem to be over; (iv) BFSI expected to grow in line with company averages?partly helped by regulatory spends and cost take out work.
Marginal changes to estimates: At around 18x FY14e , TCS trades at a significant premium to the sector (around 13-14x for other Tier-I stocks) and will require very strong execution and earnings upgrades for the stock to perform?maintain Neutral.
Valuation: Our target price of R1,625 is based on around 19x Sep’14e EPS (earnings per share). We estimate TCS? earnings will grow at around 12% CAGR (compound annual growth rate) over FY13-15e, and believe the stock should trade closer to the higher end of its historical five-year trading range of 7-24x 12-month forward earnings.
Risks: The key downside risks to our investment thesis on TCS are: (i) any significant appreciation of the rupee against USD/EUR/GBP; (ii) a prolonged recession in the US; and (iii) any margin-dilutive acquisition. Key upside risks to our investment thesis on TCS are: (i) any significant depreciation of the rupee against USD/EUR/GBP; (ii) aggressive pent-up demand from corporates in the US; and (iii) any margin-accretive acquisition.