A revival in the US financial services sector and better cost management would help TCS sustain profitable growth.
Helped by higher spending by US-based clients from financial services, healthcare and utilities sectors, Tata Consultancy Services (TCS) posted better-than-expected results for the September 2009 quarter. With the financial sector staging a recovery in the US, TCS amongst other leading domestic IT players are major beneficiaries. Revenues this quarter grew at 3.2 per cent compared to 0.5 per cent, a quarter ago. TCS also managed to secure ten large deals during the quarter including two deals worth more than $100 million each. The company is also pursuing 20 more such deals, an indication of a continued improvement in the business environment. The company’s focus on controlling cost, increasing utilisation and off-shoring helped operating margins to improve by 120 bps sequentially to 28.5 per cent. Thus, overall net profits increased 7.1 per cent to Rs 1,642 crore. A probable pick up as Gartner, a leading IT research and advisory company, suggests of IT spending to about 3.3 per cent in the year 2010 means better business volumes for the sector.
Volumes robust, pricing weak
Continuing the trend seen in the June 2009 quarter, the company delivered a 3.2 per cent growth in consolidated revenues on a sequential basis for the September 2009 quarter. This was possible on the back of volumes improving by 5 per cent, more than double Infosys’ 2.3 per cent volume growth during the September quarter. The growth in TCS’ volumes is attributed to continued ramp-ups in the BFSI vertical, volume stability in smaller emerging verticals and continued focus on its large accounts. The top 10 client contribution to overall revenues has improved significantly during the last four quarters; sequentially, it was up 90 basis points to 28.9 per cent. The company was able to extract better business from its top clients due to enhanced focus and product offerings.
On the flip side, the pricing was seen to be under pressure; prices declined by about 1.4 per cent during the quarter. TCS was not alone; Infosys also experienced a pricing decline 1.1 per cent during the quarter. One of the reasons for pricing decline for TCS could be attributed to a change in revenue mix. For instance, BPOs’ revenue share was up 40 basis points and emerging markets’ share also rose. Likewise, the share of offshore revenues, wherein realisations are typically lower, also increased. While pricing was under stress compared to stable pricing during the last quarter, it may not improve in the next few quarters given the environment wherein customers are in a mood to cut costs and improve efficiencies.
| BETTER DAYS AHEAD | ||||
| in Rs crore | FYO8 | FYO9 | FY10E | FY11E |
| Net sales | 22,618 | 27,813 | 29,721 | 33,012 |
| EBITDA | 5,696 | 7,178 | 8,266 | 9,053 |
| OPM (%) | 25.2 | 25.8 | 27.8 | 27.4 |
| Net profit | 5,060 | 5,233 | 6,300 | 7,006 |
| EPS (Rs) | 25.9 | 26.7 | 32.2 | 35.8 |
| P/E (x) | 24.3 | 23.5 | 19.5 | 17.5 |
| E: estimates | ||||
North America, BFSI leading the way
For the fifth consecutive quarter, TCS was able to consolidate its position in North America, which saw its share of overall revenue pie rising 110 basis points to 53.4 per cent during the quarter. However, Europe’s pie shrunk to 27.1 per cent from the highs of around 31 per cent in the same period. Going ahead, with around five of the 10 new large deals signed during the quarter from the UK and Europe and with clients in retail and utilities, expect things to look up for European operations from the next quarter.
Among the verticals, BFSI has shown the highest growth in all geographies, including the US. BFSI which forms 45 per cent of the total revenues saw this segment grow at 5.75 per cent sequentially higher than the overall revenue growth. BFSI was a revenue driver for Infosys also; this segment grew by 3.6 per cent, much higher than its overall revenue growth of 2.1 per cent.
However, verticals like telecom and manufacturing haven’t come out of the woods as yet. Revenues from both the segments declined 1.75 per cent and 2.4 per cent, respectively in Q2. Positively, the pressure on these segments has eased and things are starting to stabilise. In Q1, revenues from both the segments declined much higher, at 3.3 per cent and 5.7 per cent, respectively. The Hitech segment, too, appears to have bottomed out in Q1; the segment was able to muster flat growth in Q2 in comparison to 10.5 per cent decline in the previous quarter. N Chandrasekaran, CEO and MD, TCS reiterates that, “We believe that the worst is behind us in these sectors although we do not see a significant uptake in the near-term quarters.”
| ROBUST PERFORMANCE | |||
| in Rs crore | Q2 FY10 | (q-o-q) | (y-o-y) |
| Revenues | 7,443 | 3.7 | 4.5 |
| Salaries & Wages | 2,769 | 2.7 | 13.3 |
| Overseas business expenditure | 1,110 | 1.5 | -13.8 |
| Other operating expenditure | 1,438 | -1.0 | 2.6 |
| Operating profit | 2,118 | 7.8 | 16.4 |
| Net profit | 1,642 | 7.0 | 29.2 |
| Source: Company | |||
Conclusion
The resumption of hiring and wage increases by IT companies including TCS suggests that brighter days are ahead. However, even though there are visible signs of revival, the management portrays a cautiously optimistic outlook. That’s not surprising, given that even as the demand momentum in application and maintenance services segment is expected to sustain, clients continue to delay discretionary spending on large projects, especially in the enterprise and product implementation space.
Thus, hinting that even as volume growth should be healthy going ahead, it will be sometime before the pressure on pricing diminishes. For TCS, which has managed to improve its profit margins on the back of various measures including controlling costs, further improvement in margins may prove to be a challenging task in the immediate future. Also, the favourable currency cushion for profits this quarter might not be there in the next quarter.
At Rs 641.15, the stock is trading at 19.9 times its estimated 2010-11 earnings. Given the improving business environment there are gains to be made, but since the stock has outperformed the BSE Sensex and IT indices in the last four months, investors could accumulate it on dips.
