Stock Review : Tata Consultancy Services Ltd. (TCS)

 

 

Indian IT bellwether Infosys Technologies Ltd. disappointed the markets once again — reporting revenue growth below Street estimates. Tata Consultancy Services Ltd. (TCS), on the other hand, outperformed market expectations leading many to ask the question: is TCS the new gold standard for the Indian IT services sector?

Infosys has been delivering a train of disappointments for some time now. Volume growth — a key metric for IT firms — faltered again, coming in at 3.2 per cent for the first quarter of FY12, well below the Street's expectations of 4 per cent. Revenue growth came in at 4.3 per cent q-o-q. Infy cut its revenue guidance for Q2FY12 to 3.5-5 per cent from its earlier projection of 5.5 per cent. EBITDA margin declined 288 basis points q-o-q and 260 basis points y-o-y. A combination of factors affected its margins. At one time high margins were Infy's strongest differentiator from the competition. Higher SGA, wage hikes, adverse onsite-offsite mix, and lower contribution from high-margin products have all affected margins.

Things are not expected to change significantly in Q2FY11. Any pickup, say analysts, could come in only by the third quarter of the current year. The company's outlook of "cautious optimism" for the remainder of the year is not helping. Pricing recovery remains weak.

A lot of the recent hammering that the Infosys stock has taken has to do with the high expectations from the company — something it is now finding difficult to live up to. Additionally, in recent times Infy has lost perhaps its biggest brands — N.R. Narayana Murthy and Nandan Nilekani — both of whom have stepped down from the active management of the company. These two individuals, especially Murthy, gave Infosys its glam quotient — charismatic leaders that other players simply did not have.

Infy loyalists are not writing off their favourite yet. The company has indicated that things are likely to improve on the operational front. Its ongoing restructuring is expected to start showing results by the second half of this year. Three large deals are set to close in the early part of Q2. The company has informed shareholders that 12-14 large deals are in the works. Finally, it hired 9,922 employees in Q1FY12 as against its guidance of 6,500. It plans to further recruit 12,000 in Q2FY12, which means that it will stick to its full-year hiring guidance of 45,000. This goes to show that the company is optimistic about the business outlook this year.

 

TCS on a roll

Meanwhile, TCS has struck all the right chords with the market. Market sentiment turned in its favour after the company started beating long-time rival Infy in the volume growth game, which in the June 2011 quarter came in at 7.5 per cent (q-o-q). Revenue growth too came in at 7.5 per cent (q-o-q). Like Infosys, wage hikes took their toll on TCS's EBITDA margin, which declined by a lower 230 basis points to 28.1 per cent. Revenue growth on a y-o-y basis was up 34.5 per cent in Q1FY12. Some analysts say that despite this quarter's good show, revenue growth is expected to cool down from current levels and that TCS is likely to report a topline growth closer to 27 per cent in FY12.

 

What lies ahead?

The market is taking a wait-and-watch approach vis-à-vis Infosys, the darling of the markets for a long time now. Infy's valuations, however, could remain at current levels till the company completes its restructuring exercise and delivers results that beat market expectations. But that could take some time — possibly till the end of the current financial before anything significant is visible.

TCS's stock is now a prisoner of its success. Like M.S. Dhoni, TCS cannot now allow its momentum to falter. It needs to outperform its past successes as market expectations pile on. That could be a little difficult — even for the new Indian IT bellwether.