Stock Review: TCS

Strong performance comes despite a rise in staff cost, offset by favourable currency movement and productivity gains

TCS' splendid performance in the July-September quarter, reported after market hours on Thursday, was driven by 11 per cent sequential volume growth (highest in four years), largely flat pricing, and an Ebitda (earnings before depreciation, interest, taxes and amortisation) margin expansion of 70 basis points (bps).

The growth in the recently concluded quarter was broadbased, with almost all divisions recording 12-13 per cent growth and standout performance in the energy segment that grew 47 per cent. The Americas recorded 10 per cent quarter-on-quarter (qo-q) growth and Europe was up by 15 per cent q-oq. Utilisation (excluding trainees) moved up to 83.8 per cent (82.6 per cent in the June quarter).

On margins, a hit of 166bps due to higher variable pay, coupled with a 29-bps impact due to bad debt provisioning, was more than offset by favourable currency moves (103 bps), productivity gains (95 bps) and selling and general administrative savings of 54bps. Ebitda margins hit 30 per cent for the first time since 2001-02. The managements confident outlook stems from expectations of higher budgets for the next financial year, along with higher pricing by the end of 2010.

TCS continues to widen the revenue gap with Infosys, to 33.6 per cent now, and the net profit gap to 21 per cent. At 30 per cent levels, TCS Ebitda margin is inching closer to that of Infosys, which has been enjoying 30-plus per cent margins historically. Experts believe this will result in closing the valuation gap between the two companies (TCS trades at a five per cent discount to Infosys), and a possible premium. Analysts at Prabhudas Lilladher expect the volume growth to be in high singledigits, with a touch of positive bias in pricing for TCS.

The stock ended 5.7 per cent higher at `1,040.1 on Friday over its previous close, before touching an all-time high of `1,040.95 in intra-day deals. It currently trades at a P/E of 23 times 2010-11 earnings visà-vis a multiple of 25 times enjoyed by Infosys. Most analysts have revised the FY11 earnings estimates by four to 10 per cent to around `42-47 and the stock continues to be the top pick of most of them in the large-cap information technology space.