Stock Review: TCS

TCS has delivered better-thanexpected volume growth and lower-than-anticipated fall in its margins for the June 2011 quarter. And with this, the country's largest IT exporter has once again staged a more promising performance than its closest peer Infosys.

TCS' dollar-denominated revenue rose sequentially 7.5% due to strong volume growth, which is measured in billable man-hours per quarter. Infosys, in contrast, continued to lag behind with a 4.3% revenue growth.

 
The latest quarterly data also reaffirm that TCS has been able to scoop a larger share of the global IT outsourcing pie. According to an ETIG analysis, incremental revenue in the 12 months to June 2011 grew sequentially by 21.5% for TCS to . 8,865 crore. For Infosys, it grew 11.8% to . 5,320 crore.

What also makes its performance impressive is its efficiency to absorb salary hike pressures in the June quarter. Against the Street's expectation of 200-225-bp decline, TCS reported over 184 bps of sequential drop in operating margin at 26.2%. Infosys reported a much sharper fall of 300 bps in profitability.

The results show TCS has been able to match its profitability with Infy, which has long retained the mantle of running the highest margin business among top IT players. The operating margin of TCS stands a tad higher than 26.1% for Infosys. While TCS' numbers are superior to Infosys', there are a few common threads that reflect sustainable demand scenario in future. For instance, both companies have shown traction in multiyear, transformational projects, which involve a higher client engagement and hence, higher account penetration. The client addition has also remained healthy. Both players have reported a stable pricing scenario without any near-term pressure on billing rates. This puts to rest the market's worry over trembling pricing due to clients' need to curb project costs. The hiring forecast for FY12 also remains intact for both.

At current levels, valuations of both players appear to have fully discounted the upbeat demand trend in global IT outsourcing. Both stocks trade at a trailing 12-month P/E of over 24 each. A further rise in valuations looks limited in the absence of a major growth trigger.