TCS: Deep in the red

TCS' profit is down even when stripped of exceptionals

Tata Consultancy Services' (TCS) share price fell by over 8 per cent on news that that the company's net profit for the quarter ended March had fallen to Rs 611.6 crore.

It later turned out that the net profit before extraordinary items was actually Rs 464.9 crore, 34.5 per cent lower than the Rs 709.3 crore profit reported in the previous quarter ended December 2004.

The markets, however, had closed by then. Does that mean that the TCS stock would take a further beating on Wednesday?

Maybe not. Analysts had estimated an earnings per share (EPS of around Rs 52 for FY05, based on which TCS' pre-results share price got a discounting of around 25 times.

Post the massive correction after the results announcement, the stock still gets a discounting of around 25 times based on the reported EPS of Rs 48.

There just could be a further revision in TCS's valuation if analysts revise estimates for FY06 downward based on the subdued growth reported in the March quarter.

Revenues grew by 0.2 per cent sequentially last quarter, way lower than the 6 per cent growth Infosys reported. Even in dollar terms, growth was less than 3 per cent.

The only reason the company gave for the drop in growth rate (its top line had grown by 6.1 and 13.9 per cent in rupee terms in the previous two quarters) was that there was a delay in some project starts.

With revenues being flat on a sequential basis, margins took a severe hit. Operating margin fell by over 250 basis points, leading to a 8.6 per cent sequential drop in operating profit.

The drop in net profit was much more mainly because of a huge drop in other income. In the December quarter, TCS had a profit of Rs 110 crore thanks to its huge forward cover position.

In the March quarter, the average rate at which its forward contracts were booked was slightly lower than the quarter-end rupee rate, leading to a mark-to-market loss of around Rs 10 crore.

This huge shift in other income led to a 24 per cent fall in profit before tax. But even if one were to ignore this impact, it's bad enough that operating profit fell 8.6 per cent last quarter.

For the whole year ended March 2005, TCS reported a growth in sales of 36.6 per cent, lower than the 46.9 per cent growth reported by Infosys.

Even earnings growth was lower when compared to Infosys. On the positive side, TCS has been able to increase the proportion of offshore work by almost 250 basis points as a percentage of sales last fiscal.

Even the amount of fixed price contracts has come down from 55.5 per cent of revenues in FY04 to 52 per cent in FY05.

As a result, it's seen a 200 basis points year-on-year improvement in its operating margin. Nevertheless, on most parameters it continues to lag Infosys.

To add to that, there was the unexpected drop in profit reported last quarter. It's understandable, therefore, that TCS gets a marginally lower valuation when compared to Infy.

JVSL: fair valuation

That JVSL's results (including Jisco) for FY05 would be good was never in any doubt, with soaring steel prices.

Thus far, there are few indications of higher raw material costs impacting profits""-in Q4 raw materials consumed as a percentage of sales was 37 per cent, compared with 46 per cent in Q3. Operating margins were higher in Q4 than in Q3, thanks to higher sales.

Strong cash flows of around Rs 1,200 crore will allow JVSL to repay part of its debt. JVSL is now planning to raise $500mn either through an FCCB or an ADR issue.

How steel prices will move from here onwards is difficult to predict. Currently, HR coils are quoting at around $575 a tonne and galvanised steel at around $720 a tonne in the US markets. The weakening is perceived, by the management, to be temporary.

JVSL, which is not an integrated player, is looking for growth through volumes-its capacity will be at 3.8 mn tonne by March next year. But raw material costs will certainly rise going forward.

The company will also produce 0.8 million tonne more at its pelletisation unit. The full benefit of its expansion to 2.5 million tonne will be felt in FY06 since the hike in capacity from 1.8 to 2.5million tonne happened only in the last quarter.

At the current price of Rs 350, the stock is trading at a trailing multiple of 5.8 on the fully-diluted FY05 EPS of Rs 60. If the merger with Euro Ikon, Euro Coke and JSW Power goes through there could be a further dilution of 10 per cent from current levels.

An FCCB or an ADR will result in further dilution. Given the uncertainty on steel prices, the stock appears to be fairly valued.

With contributions from Shobhana Subramanian and Mobis Philipose