TCS: Ahead of expectations

While the December quarter numbers surprised the Street and the demand outlook is improving, the stock has gone up quite a bit.

TCS’ stock opened on Monday at its 52-week high but later settled at Rs 799.60, up by only a per cent over Friday’s closing price, in spite of the company reporting a surprisingly positive performance (sequentially) for December 2009 quarter, which it announced after market hours on Friday.

TCS’ net profits were up by 11 per cent sequentially as compared to the Street estimates of 2-3 per cent on the back of strong volumes, lower costs, improved productivity and stable pricing. The market’s muted reaction is not surprising considering that Infosys had already set the ball rolling by posting good set of numbers, which were better than market expectations.

Another fact is that TCS’ stock has been doing well since July 2009, wherein it has risen by over 100 per cent as compared with Sensex’s 20 per cent and Infosys’ 50 per cent rise. That’s also because, the company has consistently reported good set of quarterly numbers, including healthy volume growth and improving margins.

For December 2009 quarter, volume growth at 6.6 per cent was better than expected and the highest in the last eight quarters. TCS was able to extract higher volumes from its top client wherein revenues were up 26.6 per cent sequentially. A broad-based improvement in demand suggests that the economic recovery is gaining momentum in its key markets such as the US and the Europe.

Segments like telecom and technology, which were under pressure in the last 4-5 quarters, saw a revival in the demand helping them report a higher share of revenues. Together with stable share of the banking and financial services segment (volume growth of 7.3 per cent), the three were the key drivers of growth during the quarter.

TCS also won a $100-million multi-year deal from a manufacturing client. Overall, it closed 10 large deals and is pursuing at least 20 large more in the current quarter, which is yet another indicator of improving demand. Notably, Asia-Pacific and India are seeing strong up-tick in demand (revenues were up 23.8 per cent and 13.7 per cent, respectively) driven by growth in sectors like energy, utilities and BFSI.

TCS was also able to extract more from its employees. Its employee utilisation rates were up 160 basis points to 81.1 per cent (excluding trainees) sequentially. Better utilisations and an increase in offshore leverage helped TCS improve its operating profit margins by roughly 100 basis points to 29.7 per cent, it’s highest in more than four years.

While TCS observed flat pricing during the quarter, it does not expect billing rates to rise up soon. Positively, the management expects to maintain margins at current levels, going ahead. India’s largest software exporter added 7,700 employees (net), after reporting a decline in net additions in the last three quarters, which is again an indication of the company’s confidence over future prospects.

However, employee addition along with the rupee’s appreciation could shave of margins between 50-100 basis points, going ahead. Post the run up in TCS’ share price, the stock is trading at 21-22 times its 2010-11 estimated earnings, and is not cheap.