Analysts expect the company to report strong earnings and topline growth in FY13.
Last week, Tata Consultancy Services (TCS) added another feather to its cap as it toppled Reliance Industries as the most-valued company on the bourses. Given the software major’s sustained outperformance of its peers in the past two years, the development hardly came as a surprise.
Ever since its restructuring in 2008, TCS has been growing aggressively. In 2011, it surpassed Infosys in ways more than one. Not only did it become the new bellwether benchmark for the information technology (IT) sector, it also started trading at a higher price-earnings (P/E) multiple than Infosys. However, at current levels, the stock has a limited upside.
In a January 2 report, Avendus Research analyst Priya Sunder says that at 18.2 times one-year forward price-to-earnings (P/E) estimates, TCS is trading in line with its historic average of 18.5 times. The research firm does not see a case for a P/E re-rating to higher levels, given that the P/E to growth ratio stands at 0.9 times in comparision to a historic average of 0.8 times.
Strong growth
TCS has expanded its revenue gap with Infosys to 43 per cent (versus 33 per cent in September 2010 quarter) in the September 2011 quarter. Its relatively lower exposure to discretionary IT services (which are seeing demand pressures as customers cut such budgets) makes the company better placed to beat any demand slowdown compared to peers.
| FAVOURABLE NUMBERS | |||
| in Rs crore | FY11 | FY12E | FY13E |
| Net Sales | 37,325 | 49,455 | 58,874 |
| % change y-o-y | 24.5 | 32.5 | 19.0 |
| Ebitda | 11,112 | 15,046 | 17,770 |
| Ebitda margin (%) | 29.8 | 30.4 | 30.2 |
| Net Profit | 8,683 | 10,798 | 13,000 |
| % change y-o-y | 26.0 | 24.4 | 20.4 |
| E: Estimates Source: Avendus Research | |||
Despite the worsening macroeconomic scenario, TCS has not yet witnessed any delay or cancellation in client budgets. The management expects budgets to remain stable for the next year. The company expects to clock in a compounded annual growth of 15-20 per cent over the next three years. Brokerage firms such as Brics Securities expect it to clock in an earnings growth of 20 per cent over FY11-13. Analysts believe the company is likely to post the best volume growth for FY13 in the industry, given the higher traction in annuity-based business and lower dependence on discretionary spending.
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To what extent is this expectation of strong performance priced into the stock right now?
In a report dated January 3, 2012, analysts at Nomura say, “High street expectations are built into TCS’ current valuations. Factors like higher exposure to Europe and BFSI — segments most susceptible to a slowdown — and limited operational scope to counter cost pressure could limit upside potential. We reaffirm our ‘neutral’ rating and prefer Infosys and Cognizant over TCS."
Moreover, its operating metrics such as an utilisation of over 80 per cent and historically low-selling, general and administrative expenses don’t leave the company with enough margin levers at its disposal. Going forward, analysts expect margins to be under pressure. While Nomura is neutral on the stock, most analysts remain bullish, given the strong growth prospects.
December quarter preview
According to consensus estimates, TCS is expected to register a quarter-on-quarter topline and bottomline growth of 13.5 per cent and 14.3 per cent, respectively, for the December quarter. Its Ebitda margins are likely to expand by 120-150 basis points sequentially.
While the rupee’s fall against the dollar is likely to fuel topline growth, volume growth is expected to remain lower at three-four per cent, believe analysts. This is because the December quarter has lesser working days, resulting in less billed revenues for technology companies. Analysts also believe that pricing would be under pressure in the quarter. While the management has not witnessed any cuts in its clients’ IT budgets and expects overall budgets to remain stable in FY13, markets would keenly watch out for any comments on delays in decision-making cycle by clients.
TCS has hedged about $1.3 billion each for the December and March quarters, at Rs 46.5 and Rs 47.5, respectively, against the dollar. This is higher than hedges taken by peers such as Infosys and HCL Technologies. Hence, TCS is unlikely to gain significantly due to rupee depreciation for the second half of FY12. Further, its dollar revenues are expected to be impacted by 0.7-1.5 per cent sequentially on account of a stronger dollar versus the UK pound and the euro. Overall, the company’s net profit growth will be constrained forex losses to the tune of Rs 200 crore in the December 2011 quarter, believe analysts.