TCS: Bleeding arms

TCS' operating margins stay flat on weak rupee, subsidiary losses and higher wages

TCS'numbers for December quarter have been disappointing primarily because of poor growth in operating profit, much lower than that of its peer, Infosys.

A depreciating rupee, losses from subsidiaries and higher expenses on salaries have resulted in operating margins remaining flat.

Besides, revenue growth has been just 6.8 per cent q-o-q after adjusting for a fall in the rupee of 2.26 per cent and excluding revenues of the two acquired companies.

This has happened despite the offshore business having increased to 39 per cent from 37 per cent in the September quarter. In fact, with volume growth at 8.5 per cent, it would seem that the company has seen an erosion in prices.

However, if one were to look at just international revenues, the top line growth has been better at just over 9 per cent, after adjusting for the rupee and pricing has remained flat. But onsite profitability has come down because on higher expenses.

The operating profit growth has been just over 4 per cent after adjusting for the depreciation in the rupee, while OPM at 27 per cent is flat. TCS incurred higher expenses on employees, especially onsite compensation which was up Rs 195 crore.

However, the culprits have been the two subsidiaries, FNC in Australia and Comicron in Chile, which according to the management have posted combined losses of Rs 5 crore on revenues of Rs 39 crore, the impact on the operating margin being 60 basis points. SG&A expenses, as a percentage of revenues, have remained more or less flat at 19 per cent.

TCS has managed to contain attrition at 8.7 per cent, which is commendable. Also, utilisation in the quarter (excluding trainees) remained at 78 per cent, as in the September quarter, again creditable. The company has added 6,076 employees and bagged 83 new clients.

However, receivables at 83 days, the same level as in the previous quarter was slightly high compared with peers. At the current price of Rs 1,678, the stock trades at a multiple of around 21 times estimated FY07 compared with 25 times for Infosys. The P/E gap is likely to persist.

Exide: lead prices key

Exide Industries has seen its operating profit margin expand 230 basis points y-o-y to 15.27 per cent in Q3 FY06. Its raw material costs have grown 10.25 per cent y-o-y to Rs 190.3 crore, but as a percentage of net sales, they have declined 282 basis points to 55.7 per cent.

For battery manufacturing companies such as Exide, lead is the principal input cost. In Q2 FY06 too, the company had seen its operating profit margin improve 230 basis points y-o-y to 18.19 per cent.

Exide's sales have expanded 15.83 per cent y-o-y to Rs 341.6 crore in Q3 FY06. The company's efforts to keep raw material costs in check have helped operating profit expand 36.38 per cent y-o-y to Rs 52.18 crore in the December quarter.

The stock appears reasonably priced at about 19.3 times estimated FY 06 earnings. Going forward, the direction of lead prices is once again expected to be the key driver of profits for operating margins.

MphasiS BFL: keeping the faith

Though a little below market expectations, it was a reasonably good quarter for MphasiS BFL, one of the larger mid-tier IT-ITES companies.

The company also appears to have become more consistent in its top line growth this financial year unlike last fiscal.

Though its consolidated top line rose by 6.6 per cent q-o-q to Rs 242.45 crore in Q3 FY06, gross profit increased by 6.42 per cent because of new facilities and increased manpower in the BPO business.

There was a 13.77 q-o-q growth in its operating profit owing to a reduction in general and administrative costs to Rs 42.39 crore in the December 2005 quarter. Operating margins also improved by 110 basis points to 17.48 per cent over previous quarter.

But at the net profit level, MphasiS posted a 1.69 per cent growth to Rs 40.84 crore. Like other software companies, MphasiS too made a loss in forex of Rs 2.59 crore. On the other hand, it had a forex profit of Rs 4 crore in Q2 FY06.

In Q3, there was a decline of 200 basis points in the IT business utilsation numbers to 75 per cent and a 400-basis point fall in BPO utilisation, as the company has ramped up headcount by 16.7 per cent and 13.2 per cent in both divisions, respectively. IT services revenues grew by 6.12 per cent, while BPO revenues increased by 7.65 per cent.

The market has appreciated the company's ability to improve its operating margin, shrugging off the forex loss as the stock gained 4.66 per cent to Rs 160, trading at a reasonable FY07 P/E estimate of 12-13.

With contributions from Shobhana Subramanian and Amriteshwar Mathur