More on the seat, less on the table

SMARTSHARE

TCS' shareprice dropped from Rs 1,350 to Rs 1,090 in two sessions, a loss of about 19.25 per cent, after it declared Q4 and full-year 2004-05 results.

So, it's an understatement to say the market was disappointed. The problem is that valuations still look exposed in the context of next quarter.

TCS has not generated authoritative earnings projections for 2005-06 as yet. But Infosys' guidance suggests it is looking at 23-25 per cent EPS growth in this fiscal year and, in particular, Infy warned it expects a flat April-June 2005.

TCS consistently underperforms Infosys, so it's not unreasonable to expect that India's largest

IT company will struggle to beat EPS growth of 20 per cent in the current year. A conservative investor would probably eye an EPS growth band of 15-20 per cent in 2005-06.

At current prices, TCS discounts 2004-05 earnings 23 times and, assuming EPS grows 20 per cent, it discounts forward 2005-06 EPS by 19.

That is close enough to a Price Earning to Growth (PEG) ratio of 1:1. A bad quarter could mean a further dramatic fall in share price.

On the positive side, TCS has crossed the $2 billion mark ($2.4 billion actually) in total revenues so it's attained a size that enables it to ride out a few bad quarters.

Its geographical segmentation also gives it protection from dollar weakness and slow growth in North American markets.

TCS got 59.5 per cent of its revenues from North America in the last fiscal year and over 23 per cent came from Europe. About 11-12 per cent of earnings come from the domestic market and just 5-6 per cent from the Far East, Oceania and Africa combined.

It is likely to continue seeing quicker growth in Europe and the Far East than the US.

TCS doubled its client list to over 500 in the last year. Yet, it hasn't quite managed to derisk in the sense Infosys has. Infy doesn't earn more than 10 per cent from any given client whereas TCS picks up close to 14 per cent from General Electric alone.

Another key problem for TCS is managing currency exposure. The market has not yet figured out how to adjust for this factor. There are quarters when TCS gets things "right" with its forward contracts and is "lucky" enough to earn massive sums in other income.

In October-December 2004, TCS scored Rs 110 crore in profits from its forex hedges. In January-March 2005, it took a loss of some Rs 10 crore on this account.

We're talking about hedging $2.1 billion worth of forex in a year (or approximately Rs 8,600 crore) and the TCS treasury department's primary consideration is not that of maximising transaction profits.

In percentage terms, these fluctuations are relatively minor. TCS has a higher S&P foreign credit rating than the GoI. But the Q4 forex hedges caused a severe diminution in Q4 NP. And this situation of wild OI fluctuation on the hedge account is bound to recur.

The company aims to continue hiring but the pace may slow down. In 2004-05, TCS grew to over 44,000 employees including 10,800 new hires. This year, it expects to add 7,000-odd to the payroll.

That's a good sign "" but nevertheless, valuations could see further depression in the next quarter.