Stock Review: Tata Consultancy Services (TCS)

India's largest software company, Tata Consultancy Services (TCS), recently won a deal estimated to be worth $100-million for providing core banking solutions to Deutsche Bank. This deal is one of the biggest banking product deals of 2010 for TCS.

As a part of the deal, TCS will implement, TCS Bancs, its core banking software, in 30 countries where Deutsche Bank has operations. The deal consists of licence fees, implementation, maintenance and post-implementation services for a period of ten years.

TCS is also looking forward to some other deals, which are similar to the Deutsche contract, some of which are in the bid stage.

While software product sales and solutions for the financial services industry contribute 4-5 per cent of TCS revenues, improving overall demand led by the recovery in the US augurs well for players like TCS.

Improving demand

The Information Technology giant has won 18 large deals during the April-September period, double than the nine deals won by Infosys during the same period. Analysts say the company is a serious contender for winning large deals, thanks to its experience in implementing large, complex and mission-critical projects.

The company remains positive about its business prospects given a strong deal pipeline, visibility across all key verticals and expectations of higher IT budgets for CY11.

Robust performance

The tech giant has delivered robust performance in the first half of this financial year. Analysts at Karvy Stock Broking believe TCS would register a strong 2830 per cent dollar revenue growth in 2010-11. An indication of the improving demand scenario is the revision in its hiring guidance to 50,000 for 201011 from 40,000 guidance provided in the June quarter.

On the margin front, volatile rupee, wage hikes would be the key pressure points in December quarter, but price hikes towards the end of 201011 should cushion the margin growth. TCS' earnings before interest and tax (Ebit) margin has expanded over 300 basis points in the last four-five quarters hitting 30 per cent, led by better higher productivity and scale. Currently, margins are close to that of Infosys, which has highest margins of 33 per cent.

Some monitorables

Although the overall situation remains healthy, key monitorables include a double dip recession in major market US (which is receding), prolonged slowdown in Europe, sharp cross currency movements and appreciation of rupee against the dollar, euro and British pound. Lastly, analysts say it will be interesting to see how well TCS can maintain its margins while pursuing large deals given that pricing pressures remain.

The road ahead

With consistent outperformance on revenues and profitability, the stock (up 55 per cent) has outperformed its larger peers, the BSE IT index (up about 25-27 per cent) as well as the Sensex (up 17 per cent) in the last one year. Analysts expect TCS' valuations to improve further and its stock to trade in line with Infosys going forward –historically, it has traded at a 5 per cent discount, driven by its consistent performance.

With the prospects for TCS looking good, most analysts have a buy rating on the stock and expect an upside of 10-12 per cent over a one year horizon.