TCS: Buy

IT major TCS hardly seems like an obvious choice in a fluid global environment with the dollar looking likely to weaken, but those very facts may lead to good buying opportunities in the stock over the next week or so. The top-tier players in the IT sector, led clearly by TCS, have by now managed well-rounded growth across segments and have remained resilient to gyrations in the US and some countries of Europe in recent years. The company has a well spread out geographic-mix which would shield it from macro risks. Its relationship with large clients in the US has sustained over a long periods of time and hence a 53 percent revenue dependence on North America may not pose serious threats.

TCS has a hedged forex position of $1.7 billion for the current fiscal, at a little under Rs 45 levels. In relation to its potential revenues, this appears to be low, especially given that that the raising of the US debt ceiling could weaken the dollar vis-à-vis the rupee. This could affect realisations. But it must be noted that, $1.1 billion has been hedged for the current quarter alone and a call may be taken to increase those levels going forward. Generally an appreciation of one percent of the rupee against the dollar has a 30-40 basis points effect on margins. That still leaves some room for the likes of TCS to protect realizations.

Investors with a two-year horizon can consider buying the shares of TCS, the largest software services player in India, given its broad-based growth in key segments and increased focus on transformational deals.

At Rs 1,056, the share trades at 18 times its likely per share earnings for FY12. This is at about the same levels as Infosys, even though TCS has, in recent times, enjoyed a re-rating due to superior performance. Given the recent correction, any further declines due to broader market sentiments can be used to accumulate the stock.

Robust volumes, stable pricing, strong large-client additions and clear leadership in metrics such as utilisation have meant that TCS, while maintaining a sound growth trajectory, has also caught up with Infosys in terms of EBIT margins as well in the recent quarter.

In FY-11, while revenues increased by 24.3 per cent to Rs 37,324.5 crore, net profits expanded by 29.5 per cent to Rs 9,068 crore. The momentum has continued in the recent June quarter too, with the company outpacing peers in its financials.

What has been even more desirable is that TCS has been steadily improving its margins over the last few years and has negated the perception that the company chases revenues at the cost of margins. Its operating margin, at 31.6 per cent, is among the best in the industry and the company has indicated that it would be able to maintain those levels going forward.

Broad-based growth

TCS has witnessed growth across the verticals that it operates in, even as its largest segment BFSI (43.3 per cent of revenues) continues to witness sustained momentum. BFSI, manufacturing, and retail and distribution have been growing at over 25 per cent on a year-on-year basis in terms of revenues over the past few quarters.

What comes as the icing on the cake is the fact that even the telecom vertical is growing at healthy double-digit rates. Growth in telecom has been driven by emerging markets such as India and Middle East and Africa (MEA) with new operators ramping up operations.

That this has been achieved when peers such as Infosys and HCL Technologies are still witnessing pressure in the troubled telecom vertical suggests that TCS may be better positioned to tap incremental opportunities.

In terms of its service-mix too, the higher billed offerings such as enterprise solutions, infrastructure services and global consulting have been growing at double-digits on a sequential basis for the last four-five quarters. This has had the desirable effect of enhancing margins for the company.

More importantly, it is also indicative of the fact that TCS has been able to tap into discretionary spending of clients in a significant way. The other key aspect where TCS has been ahead of competition has been on winning transformational deals. Transformational projects involves delivering end-to-end services to cater to the entire IT requirements of clients and tend to be large in size and require complex execution capabilities. All these facts are reflected in the way the company has added large clients.

Key metrics improve

Over the last four quarters, the number of customers contributing $100-million plus to revenues has increased from seven to 10. The number of clients in the $50-million plus category has increased by nine to 33 currently.

Such large deals would lend substantial revenue visibility along with providing manoeuvrability on deciding on delivery and optimising costs by creating a favourable people-mix offshore.

TCS has also witnessed volume (person-months billed) growth of 4.7-11.2 per cent on a sequential basis over the last five quarters that has been well ahead of peers. Even so, pricing has been stable for the company, though there are no signs of uptick.

This is exemplified in the utilisation level of the company, which has been close to 83 per cent (excluding trainees) consistently for the past several quarters. This too is among the highest in the industry where most players tend to sport figures of less than 80 per cent.

With a headcount in excess of 200,000, by sheer numbers, this high level of utilisation would still have enough manpower which would allow it to cater to increased demand going forward.

A lesser bench proportion would also mean better resource allocation and cost containment as well. Attrition, a key execution risk, is at 14.8 per cent and appears well under control compared to the industry average.

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