Unlike Infy, TCS strikes a bullish note on growth

Tata firm's net up 48% in March quarter to Rs 5,358 cr, in line with Street expectations

As two of India’s largest information technology (IT) services companies announced their financial results on consecutive days, the contrast between their tones was quite striking. While Infosys Technologies was more focused on “ramp-downs” and “continued pressure” in its post-result press conference on Tuesday, Tata Consultancy Services (TCS) the next day talked more about how “2014-15 will be much better than 2013-14”.

TCS posted a 48.2 per cent rise in net profit for the quarter ended March 31 (according to Indian generally-accepted accounting principles, or GAAP), in line with the Street’s expectations. Its consolidated revenue rose 31.2 per cent over the year-ago quarter to Rs 21,551 crore.

 

The company’s earnings before interest, taxes, depreciation and amortisation (Ebitda) margin in the quarter stood at 30.9 per cent, 247 basis points higher on an annual basis but down 53 basis points sequentially. The numbers, as expected, were much ahead of closest peer Infosys, which managed to meet Street expectations but fell short on its guidance for 2014-15.

While TCS reported a strong 2.6 per cent sequential volume growth in the fourth quarter, Infosys lagged with a meagre 0.4 per cent volume growth. Also, TCS continues to be optimistic about the road ahead and expects 2014-15 to be a better year than the previous one. The management expects healthy traction in discretionary spends, digitisation and regulation-driven expenditure this financial year.

Infosys, in comparison, had remained cautious on discretionary spending. Its 2014-15 dollar revenue growth guidance of seven-nine per cent is only a little more than half of industry body Nasscom’s growth projection of 13-15 per cent for the IT sector this financial year.

TCS Managing Director & Chief Executive Officer N Chandrasekaran said he believed discretionary, regulatory and digitisation would be key areas of growth this financial year. In 2013-14, TCS’ revenue grew 16.2 per cent in dollar terms to $13.44 billion. Among key sectors, banking, financial services and insurance (BFSI) and retail would see strong growth this year, said Chandrasekaran.

Infosys CEO & MD S D Shibulal had on Tuesday said: “Revenues were down due to ramp-down in certain verticals and continued pressure in sectors like retail, hi-tech and consumer packaged goods. Discretionary spend continues to be slow and deal cycles in this segment are longer.”

For the two IT services giants, Ebitda margins also showed divergent trends in the quarter. But while TCS’ margin contraction was driven by reinvestments in the business, Infosys’ expanded due to a tab on selling, general and administrative (SGA) expenses. Notably, TCS has managed to maintain this metric between 28 per cent and 31 per cent over the past eight-10 quarters. Infosys’ margins, though, have come down from about 33.7 per cent in the December 2011 quarter to 28.3 per cent at present.

On other key parameters, too, TCS appears to be on a better wicket. A lower attrition rate of 11.3 per cent in the past 12 months (versus 18.7 per cent for Infosys), higher employee utilisation rate, commentary on deal pipeline and robust hiring plans are some examples.

While Infosys' sequential net profit growth in the March quarter was 0.3 per cent to Rs 2,883 crore, TCS' was slightly better at 0.5 per cent to Rs 5,358 crore. Also, Infosys' quality of earnings remained weak, as its revenue fell 1.2 per cent and net profit was driven by higher other income (a volatile and non-core income stream).

Thanks to TCS' consistently strong and industry-leading financial performance, its shares trade at a high premium to the Infosys scrip. At Wednesday's closing price, TCS trades at 19.7 times its 2014-15 estimated earnings, compared with Infosys' 15.4 times on the same parameter. Analysts believe the premium is justified, given TCS' sustained superior performance versus Infosys. They say the valuation gap will continue in the medium term and could shrink only after a meaningful improvement in Infosys' financial performance.

Nitin Padmanabhan, technology analyst, Espirito Santo Securities, says: "TCS results are broadly in line with expectations. The TCS scrip, though, looks expensive at the current level. We believe TCS could post 16-17 per cent dollar revenue growth in 2014-15. While the valuation gap between the Infosys and TCS stocks is likely to continue, we think Infosys can reduce some of that gap as its financial performance improves. We expect Infosys' revenues to become more predictable over the next 12-18 months and are bullish on the Infosys scrip. We remain neutral on TCS, given the rich valuation."

Since the return of its founder N R Narayana Murthy as executive chairman last year, Infosys has been taking various measures to boost confidence of its employees and clients, as well as prepare itself for higher growth. Most analysts believe in a Infosys turnaround story and are, therefore, bullish on the scrip (given an inexpensive valuation).

"We maintain Infosys is taking the right steps by re-focusing on traditional service lines. A supportive macro environment will aid a turnaround. We think the guidance for 2014-15 and operational efficiencies will support margin expansion. This should help Infosys deliver more than 14 per cent earnings-per-share growth in rupee terms between 2013-14 and 2015-16," says Rumit Dugar, IT analyst at Religare Capital Markets. TCS also remains the top pick of analysts, given its strong and consistent performance and robust visibility. But current valuations cap significant upsides.