TCS is India's largest technology company and had a terrific run in 2013. The management's commentary in the latest quarter as in the past couple of quarters has been quite optimistic compared to its peers. TCS has been walking the talk too. Its order execution and growth across verticals has been industry leading. TCS trades at a reasonable 1x its three-year PEG ratio. With 2014 set to be better than last year, earnings growth is likely to sustain. Any upside in earnings will make TCS an even more attractive proposition.
Strengths
TCS has a lead of 50 per cent in revenues and 56 per cent in profits over its next biggest competitor Infosys (FY13). The company reported quarterly revenue growth that was double of Infosys (December 2013 quarter). Europe is the new playing field and TCS has started reflecting gains from the European markets. Moreover, a higher hiring target set by the company is a positive indicator of revenue visibility.
Growth drivers
Improved outlook for 2015. Perhaps the best news for TCS investors is that the CEO N Chandrasekaran has guided that he is positive on growth outlook and that he expects a better 2014 compared to the previous year. A lot of that growth is expected to come from improved discretionary spends especially in retail and manufacturing verticals. The recovery in the US economy is likely to fuel BFSI spends, which is the largest vertical for TCS. Other areas that the company pointed out would see traction are in the 'digital' space with services such as cloud, analytics, mobile and social media seeing growth in demand. According to UBS Securities, TCS is likely to see a dollar revenue growth of 19.7 per cent in FY15.
Already on a strong wicket. The company reported a broad based revenue growth of 3 per cent in the December 2013 quarter. Volume, growth at 1.8 per cent was muted on account of seasonality. The main revenue drivers in the discretionary vertical were consulting (up 4.4 per cent q-o-q in rupee terms) and Enterprise Applications (up 3.5 per cent) and on the maintenance side it was IMS (up 3 per cent) and BPO (up 3.1 per cent). TCS sealed 8 multi-million and multi-year deals in financial services, retail, healthcare, telecom and transportation verticals. A number of deals especially in the retail sector were postponed to the fourth quarter of the current financial owing to the holidays at the end of December.
European resurgence. Another trend the company saw was Europe growing faster than the US market. The UK grew 4.2 per cent (q-o-q, December 2013 quarter) while rest of Europe grew at 6.7 per cent (q-o-q). Overall Europe's growth was around 5.5 per cent and the US growth was 2.1 per cent (q-o-q). The management continues to expect the Europe to outpace the US market for the next 2-3 years.
The digital era. A new opportunity that is shaping up for tech companies is digital. Digital comprises mobile, social and data; and mobiles as we know are big business now. Social is something very few can get away from while cloud services are slowly but surely finding their place. N Chandrasekaran in a recent interview to media estimated this opportunity to be around $4-5 billion in the next three years. The company expects digital to constitute a significant portion of revenues FY15 onwards.
Gains reinvested. Realisation levels were up 74 basis points in the quarter ended December 2013. This saw gross margins expand 30 basis points (q-o-q). But TCS also reinvested these margin gains into SG&A expenses, as a result of which Ebitda margin contracted by 25 basis points to 31.4 per cent. The management has guided that such investments would likely be made in the future to expand its geographical, service and product offerings. According to ICICI Securities, TCS could report EBIT margins of 28.4 per cent and 27.7 per cent for FY15 and FY16 respectively, at the higher end of the management's guidance of 26-28 per cent.
Forex benefit. TCS booked forex gains of ₹295 crore in the December 2013 quarter compared to the losses of ₹377.3 crore in the second quarter of this financial. The forex gain coupled with lower taxes helped earnings per share jump 13 per cent over the immediately preceding quarter.
Higher hiring. An indirect indicator of how strong the business environment appears to the management can be gauged from hiring trends.
TCS has upped its hiring target for FY14 from 50,000 gross to 55,000. The December 2013 quarter already saw headcount grow by 1.9 per cent (q-o-q). Quarterly attrition rate annualised stood at 12.9 per cent compared to 14 per cent in the immediately preceding quarter.
Concerns
India revenues were the only geography that dragged with a decline of 8.6 per cent (q-o-q). According to the company, many deals that it was involved in included government and public sector enterprises, which were not closed. The company itself walked away from some because they did not meet its requirements. The India business could remain down for at least the next three quarters given that elections are near and any big decisions may be put on the backburner.
Valuation and outlook
TCS trades at a PE of 25x. Earnings for the company have compounded at an annual rate of 25 per cent in the last three years. Thus, the stock still trades at a reasonable 1x its three-year PEG ratio. With the outlook for the current year already considered better than 2013, TCS may surprise on earnings growth in FY15. TCS is firing on all cylinders. Its broad-based growth across verticals and geographies (barring India of course) and strong execution puts TCS on the path of sustained momentum. The management sees further possibility for margins sustaining. With its market leading performance.
TCS is among the best picks in the sector. TCS has a lead of 50 per cent in revenues and 56 per cent in profits over its next biggest competitor, Infosys (FY13). With fundamentals better than most players, TCS is likely to continue its market outperformance. Buy.
This article was originally published on March 26, 2014.
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