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Mr S. Ramadorai, CEO and MD.

K. Venkatasubramanian

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Investors with a one-year perspective can buy the shares of Tata Consultancy Services (TCS), considering the reasonable valuation and stable business prospects. Over the medium term, TCS, as other frontline companies may be well-placed to create a non-headcount-linked growth story, a factor that becomes critical in managing costs and climbing the value chain.

In an uncertain market, exposure to frontline stocks in this category may be safer bet as they may be better placed to weather a rough macro-environment. At Rs 839, TCS trades at 16 times its FY-08 earnings and 14 times its likely current year earnings.

This is at a sizeable discount to other frontline IT stocks such as Infosys and Satyam. The stock did not participate in the frontline IT stocks rally, where others delivered 25-50 per cent returns from their January lows.

Since March, the IT sector has been buoyed by two factors — a 7 per cent depreciation of the rupee against the dollar (to Rs 43 levels) enhancing realisations, and extension of the STPI tax sop by a year to 2010. What may have resulted in a potential tax-incidence of 20-22 per cent would continue to be 12-15 per cent at least till March 2010. TCS will also be a key beneficiary of both these trends.

The stock’s relative underperformance in recent months can be explained by earnings disappointment in the March quarter. TCS’ numbers for March 2008 showed lower net profits and muted revenue growth relative to the previous quarter, even as Infosys and Satyam reported more favourable numbers. This was attributable to project delays and transition periods in some projects that were not billed during the same quarter.

The company has indicated that these transition revenues would flow in from the middle of the June quarter. Greater clarity on client spends, especially in the troubled BFSI segment, may emerge in the second half of the year. If positive results are delivered and client budgets are fully firmed up for the year, the TCS stock has a potential to rally, given its lower valuations.

There are also a couple of positive developments on the business front. The company has established TCS financial solutions as a separate strategic business unit (SBU) recently, which will be a high-margin product business specialising in universal banking solutions. These may require lower levels of customisation, paving the way for reduced manpower on projects and quicker implementation. But where systems integration, application development and maintenance are required, the regular BFSI vertical would come to the fore. A revenue stream comprising product licence, implementation, maintenance and upgrade fees would flow in. This may also expand margins. However, all this may take place over two-three years.

TCS also has headroom for tweaking key operating metrics. The company is looking at increasing the offshore component of its work so as to optimise costs. This is now at 42 per cent and may go up further, even as clients in the UK and Europe are tilting towards a larger offshore (low-cost destinations) component to work.

The company has also indicated an increase in the fresher/lateral hire ratio, thereby reducing manpower costs. Utilisation, at 75.1 per cent in end-March, could also be raised to 80 per cent levels to enable volume growth. Recent announcements indicate that the large deal flow has once again commenced for TCS after a lull, with $100-million-plus deal wins such as that with Scottish Water.

A high concentration of BFSI clientele (43.6 per cent of revenues) compared to Infosys, Satyam or HCL Tech means that TCS is exposed more to pressure points in the global financial services space.

A deeper and prolonged slowdown in the US may affect client IT spends and, thus, the deal pipeline.

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