Thursday, January 21, 2010

>Tata Consultancy Services (MACQUARIE RESEARCH)

TCS delivered strong 3Q results that exceeded our and street expectations on all financial parameters. EPS of Rs9.2 (up 10.7% QoQ and 32.9% YoY) was 15% higher than our and consensus expectation of Rs8. We maintain our positive view on the sector and are comfortable with our above consensus US$ top-line growth of 27% for the sector leaders in FY11E. Maintain TCS as our top pick in the sector.

Management comments point to broad-based recovery. Our positive thesis on the sector is based on demand recovery playing out for the Indian IT vendors in CY 2010. Sequential improvement across major verticals and management expectations of having turned the corner in Manufacturing, Telecom and Hi-Tech verticals strengthen our argument of revenue resurgence in FY11E. (Please see Figure 3 and Figure 4.)

TCS expects aggressive FY11E hiring, lateral hiring picks up in 3Q. Similar to the trend we have seen at Infosys, TCS management indicated their intent to hire aggressively in FY11E to meet the pick-up in demand. The company added 8,239 trainees in 3Q, ahead of its guidance of 8K given in 2Q. Importantly, lateral hiring picked up significantly in the quarter (3K in 3Q vs. 2K in 2Q). TCS expects to add another 3K lateral employees in 4Q FY10. Aggressive plans for a FY11E employee addition and significant uptick in lateral hiring signals a robust revenue growth outlook for the sector.

Good 3Q results. TCS delivered stellar results with US$ revenue growth of 6.3% QoQ (vs. Infosys at 6.7%), INR revenue growth of 2.9% (vs. 2.8% for Infosys) and QoQ EBITDA margin expansion of 100bp (vs. 90bp for Infosys).

Strong volume growth helps offset exchange headwinds. TCS delivered 6.6% QoQ volume growth in the quarter (vs. 6.1% for Infosys). This helped the company to deliver 2.9% QoQ INR revenue growth despite a 1% negative impact on revenues due to INR appreciation. Pricing for the quarter remained flat (vs. +0.2% QoQ pricing improvement for Infosys).

Improved productivity (+220bp), offshore leverage (+17bp), SG&A gains (+36bp), and currency (-167bp) resulted in a ~100bp margin expansion in 3Q.

Earnings and target price revision
No change.

Price catalyst
12-month price target: Rs830.00 based on a DCF methodology.
Catalyst: Finalisation of client IT budgets in February 2010.

Action and recommendation
TCS is our top pick, margin surprise poses upside risks to our estimates. Favourable FX movement (current INR/US$ expectation of 42 by Mar’11), would imply upside to our margin forecasts for Indian IT vendors.

To read the full report: TCS