TATA Consultancy Services (TCS)

   TATA Consultancy Services' (TCS) performance in the June 2010 quarter reaffirms the company's ability to take advantage of the gradual recovery in the demand for IT services and solutions in the US and Asian markets. The country's largest IT exporter delivered betterthan-expected results for the quarter backed by volume pick-up and better cost management. The company is likely to benefit the most from the improving demand traction even in future given its strong presence across major global markets. Further, its growing influence in the domestic market for IT services adds to its strength.

BUSINESS:

TCS is the country's biggest IT services provider with an annual revenue of Rs 28,609 crore as of June 2010. With a share of 55% in total revenue, the US is its largest market. The company also offers services to clients in Europe and Asia Pacific.

   TCS had faced lower demand from its key markets during the economic slowdown a year ago. Its revenue and profitability dropped since clients had either postponed or cancelled new projects. But since the March quarter, the demand has again picked up. In the June quarter, it reported a strong 8.2% sequential growth in billed manhours or volumes on top of 4% rise in the previous quarter.TCS has increased its hiring target to 40,000 for FY11 from 30,000 set earlier. While a part of this increase is to refill the vacancies created by higher attrition rates, a major chunk of it is to cater to higher demand.

FINANCIALS:

The company's net sales rose at a compounded annual growth rate of 25% in the past five years. Operating profit before depreciation grew by 28% whereas net profit rose by 29% by similar comparison.

   TCS had taken a major hit in profits in FY09 due to foreign exchange losses from revenue and cash flow hedging strategies. The losses no more bother the company since most of the loss making hedges have been realised. As of June 2010 quarter, it had $500 million of outstanding hedges. With lower hedging losses and improved operating efficiency, the companies operating margin has again reached to its normal level of 27% from the lows of 22% eight quarters ago.

GROWTH TRIGGERS:

Over the years, TCS has invested substantially in overseas facilities — sometimes through acquisitions and at others through its own development centres. More than 7% of its workforce is located at its overseas branches. This makes it possible to offer services from either offshore development centres (ODCs) or from near-shore centres as per the needs of clients.

   As a part of this initiative, TCS has set up centres in Asia Pacific. Of these, centres in China and Australia have shown impressive growth in the June quarter and are likely to do so even in the coming quarters according to the TCS management. This is on account of the traction in business from clients in the Asia-Pacific region, which grew in double digits sequentially in the June quarter. TCS is also witnessing a revival in transformational long-term deals, which went on the back burner during FY09 due to the slowdown. The company bagged 15 large deals during the first quarter over and over and above the 10 big orders in the previous quarter. A recovery in verticals including banking, financial services, and insurance (BFSI), retail, energy and utilities is driving the growth in new deals.

   Another key driver for growth in future is the presence of TCS in the fast-growing Indian market. The company caters to both the government and private sectors in the country. In the June quarter, this business grew by 6% sequentially. The company expects to retain the momentum going ahead.

VALUATIONS:

The stock is currently trading at 22 times its trailing 12-month earnings. IT has been able to post more than 30% growth in its earnings for the 12 months ended June 10. While, the effect of lower earnings in the previous comparable period due to forex losses is one reason for the robust jump, the other trigger is the higher business volumes and improved operational efficiency. Given these factors, the company is expected to grow its profit better than the likely industry growth rate of 18-20% for FY11. At an expected

   earnings growth of 22%, TCS attracts FY11 forward P/E of 18. This is at a significant discount to the FY11 estimated P/E of over 24 for its closest peer Infosys.

CONCERNS:

TCS takes more number of days to collect its outstanding sales on average compared to Infosys. Further, this number has increased significantly in the June quarter. TCS's receivables days rose to 77 days from 71 days in the March quarter. The number is higher than 60 days for Infosys. Higher the number, higher would be pressure on working capital requirements and hence on operating efficiency.