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Initiat ing Cove rage Not e Tata Consultan cy Services Li mited Sector: I T Rating:
Initiat ing Cove rage Not e Tata Consultan cy Services Li mited Sector: I T Rating:
Initiat ing Cove rage Not e
Tata Consultan cy Services Li mited
Sector: I T
Rating:
BUY
Targ et Price: `1388.70
T ata Co ns ult an cy Se rvi ces The fr on tie r o
T ata Co ns ult an cy Se rvi ces
The
fr on tie r o f t he
‘Be ll we the r’
Ra ce
Strong V olumes G rowth
GNDM TM
Key Dri vers &
Enhance d Utiliza tion
Positiv es to
pro pel
perfor mance
R&D
Non Line ar Initiat ives
KEY HEADWIN DS
E uropean D
ebt Crisi s
C urrency H
eadwind s
Vi sa issues in the US
Investme nt Thesis
Rese arch A nalyst:
Nit in Prakash Daga
AVP Resear ch
Micro sec Capita l Limited
npd aga@micro sec.in
‐ 1 ‐
+9
1 33 3051
2172
Size Does Mat ter
Analyst: n pdaga@micro sec.in
Tata Consultancy Services Limited Table of Contents: S. No. Contents Page No. 1. Investment Case………………………………………………………………………………………………………………… 03

Tata Consultancy Services Limited

Table of Contents:

S. No.

Contents

Page No.

 
  • 1. Investment Case…………………………………………………………………………………………………………………

  • 03 - 03

  • 2. Company Background……………………………………………………………………………………………………………

  • 04 - 04

  • 3. Business Segments………………………………………………………………………………………………………………

  • 05 - 06

  • 4. Industry Overview…………………………………………………………………………………………………………………

  • 07 - 09

  • 5. Investment Thesis…………………………………………………………………………………………………………………

  • 10 - 14

  • 6. Peer Group…………………………………………………………………………………………………………………………

  • 15 - 16

  • 7. Key Management Personnel……………………………………………………………………………………………………

  • 17 - 17

  • 8. Valuation……………………………………………………………………………………………………………………………

  • 18 - 18

  • 9. PE Bands……………………………………………………………………………………………………………………………

  • 18 - 18

  • 10. Key Risks……………………………………………………………………………………………………………………………

  • 19 - 19

  • 11. Financials……………………………………………………………………………………………………………………………

  • 20 - 20

  • 12. Disclaimer……………………………………………………………………………………………………………………………

  • 23 - 23

 

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Analyst: npdaga@microsec.in

TCS – Size does Matter Sector- Information Technology BUY We rate Tata Consultancy Services Limited (TCS)

TCS – Size does Matter

Sector- Information Technology

BUY

We rate Tata Consultancy Services Limited (TCS) a ‘BUY’. Our rating underpins

Market Data & Target Price

Current Market Price (`)

1,136.20

Target Price (`)

1,388.70

Annualized Upside

12.7%

52 Week High / Low (`)

1,247.00 / 725.50

Market Capitalization (In ` Crs)

222,379.45

TCS – Size does Matter Sector- Information Technology BUY We rate Tata Consultancy Services Limited (TCS)

STOCK SCAN

BSE Code

532540

NSE Code Bloomberg Ticker

TCS TCS IS Equity

Face Value (`)

1.00

FY2011 EPS (`)

46.32

Current P/E

25.9x

Average P/E

24.2x

Beta vs Sensex

0.91

PEG Ratio

1.14

Average Daily Volmes

193,275

75 50 25 0 -25 Return (%)
75
50
25
0
-25
Return (%)

24-Jun-10

23-Sep-10 23-Dec-10 24-Mar-11 23-Jun-11 TCS SENSEX
23-Sep-10 23-Dec-10 24-Mar-11 23-Jun-11
TCS
SENSEX

the company’s leading position in the Indian IT space, strong growth in business volumes, GNDM TM for better catering of customers’ needs, non linear growth drivers, strong R&D, and its history of rewarding shareholders. However, a dull European business environment and currency headwinds

impede our optimism a bit.

Investment Case

  • TCS’ large size enables it to provide one stop solutions for entire set of customer needs. This factor puts the company in a better position while negotiating for new deals and helps it to retain business from the existing clients.

  • Under GNDM TM model, TCS established delivery centers at different geographical locations across the globe. The model enables the company to collaborate on projects and leverage the asset base of different locations.

  • TCS is also focusing on non linear levers to drive its future growth, which include – Financial Solutions, Platform based BPO, and iON. These solutions, with strong market response may help the company keep its growth levers intact in the upcoming quarters.

  • TCS’ R&D initiatives are focused on staying competitive in the market and remain proactive to changes in the IT space, the company possesses wealthy IP assets with 68 patents granted across various domains.

  • In addition, TCS’ management continues to reward shareholders with regular dividend payouts, which add on to their returns periodically. The company has distributed ~48% of its cash generated since FY2005 as dividends.

TCS – Financials at a glance (all data in ` Crores unless specified)

TCS – Size does Matter Sector- Information Technology BUY We rate Tata Consultancy Services Limited (TCS)

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Analyst: npdaga@microsec.in

Tata Consultancy Services Limited Company Background TCS is one of the most integral parts of ~$98.7

Tata Consultancy Services Limited

Company Background

TCS is one of the most integral parts of ~$98.7 Bn Tata group. Foundation of it was rooted in formation of a division of Tata Sons in 1968. Over the four decades of its formation, the division assisted in shaping the Indian IT space. The division, which got its first international client in 1971, crossed `10 Bn revenues mark in late nineties. TCS was incorporated as RR Donnelley (India) Private Limited in January 1995, which was wholly owned by RR Donnelley and Sons Company through its Mauritius subsidiary. Tata Sons acquired the entire stake of RR Donnelley and Sons Company in RR Donnelley (India) Private Limited during June 2000. With this, the latter became a wholly owned subsidiary of Tata Sons. The company’s name was subsequently changed to Orchid Print Media Limited in March 2001 and finally it became Tata Consultancy Services Limited (TCS) in December 2002. The company’s subsequent progress is depicted briefly in the graph below:

Source: Company Data, Microsec Research
Source: Company Data, Microsec Research

From just a business division of its parent Tata Sons, TCS emerged as the leading software exporter in the Indian IT industry. The company’s top line touched $8.2 Bn in FY2011 while it reported Net profits of more than $1.9 Bn during the year. In addition, TCS is amongst one of the largest employers of the country with employee base of 198,614 at the end of FY2011. The company is present across the globe with 145 offices in 42 countries. Moreover, TCS had 106 delivery centers in 20 countries at the end of the year. In ` terms the company’s top line stood at `37,324.51 Crores whereas its bottom line remained at `9,068.04 Crores. TCS earned more than 90% of total revenues from the global markets during the year.

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Analyst: npdaga@microsec.in

Tata Consultancy Services Limited Business Segments TCS segregates its revenues on the basis of geograph ies

Tata Consultancy Services Limited

Business Segments

TCS segregates its revenues on the basis of geographies it caters to. In addition, the company divides the top line based on revenues from different industry verticals and according to Service Offerings.

On a geographical basis, TCS primarily reports four segments – US, Europe, India, and Rest of the World (RoW). While the US continues to account for a large chunk of the company’s top line, business from Europe and RoW are gaining momentum. As a result, the share of these geographies, on a y-o-y basis, increased in TCS’ top line whereas contribution by US witnessed a decline in Q4 FY2011. Growth in revenues from India remained in line with the company’s overall top line expansion. Consequently, the share of country in TCS’ top line declined just 10 basis points (bps) y-o-y to 8.80% in Q4 FY2011. The following exhibit reflects the geographical revenue break up of TCS in Q4 FY2011 and Q4 FY2010.

Source: Company Data, Microsec Research
Source: Company Data, Microsec Research
Tata Consultancy Services Limited Business Segments TCS segregates its revenues on the basis of geograph ies

The industry verticals, which TCS caters to, are broadly divided into 10 heads. These heads are – Banking, Financial Services and Insurance (BFSI), Manufacturing, Retail and Distribution, Hi-Tech, Life Sciences and Health Care, Transportation, Energy and Utilities, Media and Entertainment, and Others. BFSI continued to account for a large share of the company’s top line pie. However, its share has declined, over the last year, in Q4 FY2011. Nevertheless, new areas such as – Transportation, Life Sciences and Health Care, and Media and Entertainment registered an enhanced revenue share, on a y-o-y basis, in Q4 FY2011. This is shown in the exhibit below:

Tata Consultancy Services Limited Business Segments TCS segregates its revenues on the basis of geograph ies

Source: Company Data, Microsec Research

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Tata Consultancy Services Limited Business Segments TCS segregates its revenues on the basis of geograph ies

Analyst: npdaga@microsec.in

Tata Consultancy Services Limited As per Service Offering segmentation, TCS report it s top line in

Tata Consultancy Services Limited

As per Service Offering segmentation, TCS report its top line in five segments – IT Solution and Services, Engineering and Industrial Services, Infrastructure Services, Global Consulting, Asset Leverage Solutions, and Business Process Outsourcing. IT Solution and Services, further divided into Application Development and Maintenance, Business Intelligence, Enterprise Solutions, and Assurance Services, continues to remain the dominant revenue contributor in Q4 FY2011. Among these services, Application Development and Maintenance account for the highest share. The company’s revenue spread across the Service Offerings is depicted below:

Source: Company Data, Microsec Research
Source: Company Data, Microsec Research

Trend of change in geographical mix is expected to continue in the upcoming quarters as well. While share of matured economies such as Europe and US is expected to decline gradually, India and RoW may witness incremental share in top line. Among the Industry verticals, Health Care, Media and Entertainment, and Life Sciences may beat the company’s average growth. While IT Solution and Services likely to remain key contributor amid the services, Infrastructure Services are expected to gain momentum. As a result, share of these verticals in TCS’ top line is expected to increase in the medium term.

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Analyst: npdaga@microsec.in

Tata Consultancy Services Limited Industry Overview Global Scenario According to National Association of Software an d

Tata Consultancy Services Limited

Industry Overview

Global Scenario

According to National Association of Software and Services Companies (NASSCOM) estimates, global spending on technology and related products and services augmented 4.0% y-o-y to $1.6 Tn in 2010. IT Services spend increased 1.4% y-o-y to $574.0 Bn while BPO spend jumped 3.9% to $158.0 Bn during the year. Among the geographies America remained on top followed by Europe and Asia Pacific (APAC) Region. A brief overview of the same is depicted in the graph below:

Global IT Services Spend – Geographical Break up

Source: Nasscom, Microsec Research
Source: Nasscom, Microsec Research
Tata Consultancy Services Limited Industry Overview Global Scenario According to National Association of Software an d

Global BPO Spend – Geographical Break up

Source: Nasscom, Microsec Research
Source: Nasscom, Microsec Research
Tata Consultancy Services Limited Industry Overview Global Scenario According to National Association of Software an d

The global industry trends remained positive in 2010 and expected to stay upbeat in the upcoming quarters as well. Players in some of the favorable IT destinations such as India are expected to significantly benefit from the same. The country’s dominance is likely to continue with its expertise and ability to offer quality services in the IT and ITES domains.

7

Analyst: npdaga@microsec.in

Tata Consultancy Services Limited Indian IT Industry The Indian IT industry remained a key contributor to

Tata Consultancy Services Limited

Indian IT Industry

The Indian IT industry remained a key contributor to India’s overall economic development. According to NASSCOM IT BPO sector strategic review 2011, Indian IT sector is estimated to clock revenues of $88.1 Bn in FY2011. While a major part of the same is expected to continue coming from overseas software markets, hardware and domestic markets also accounts for a sizable portion of industry.

Indian IT Sector Source: Nasscom, Microsec Research
Indian IT Sector
Source: Nasscom, Microsec Research
Software Revenues
Software Revenues

Of total revenues of $88.1 Bn, $12 Bn came from Hardware segment while IT Software and Services accounted for the remaining $76.1 Bn. Moreover, exports contributed for ~78% of the total revenues of IT Software and Services segment. Aggregate direct employment from the IT space is estimated to reach 2.5 Mn in FY2011. In addition, the industry created ~8.3 Mn indirect jobs as per NASSCOM estimates. The sector’s share in total Indian exports grew from just 4% in FY1998 to 26% in FY2011. Furthermore, the industry’s revenues as a percentage of GDP increased from 1.2% to an estimated 6.4% during FY1998-2011 period.

Revenues as a % og GDP 9.0% 6.0% 3.0% 0.0% 1998 2011E
Revenues as a % og GDP
9.0%
6.0%
3.0%
0.0%
1998
2011E

Source: Nasscom, Microsec Research

Share in total Indian Exports 30.0% 20.0% 10.0% 0.0% 1998 2011E
Share in total Indian Exports
30.0%
20.0%
10.0%
0.0%
1998
2011E

Among geographies, US is likely to remain the largest contributor whereas Banking Financial Services and Insurance (BFSI) is estimated to be the largest vertical in the country’s export pie. Additionally, IT Services segment represented 57% of total exports followed by Business Process Outsourcing (BPO), and Engineering Design and Products Development segment. We expect this analogy to remain intact in medium term as well.

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Analyst: npdaga@microsec.in

Tata Consultancy Services Limited Outlook In its Strategic Review 2011, NASSCOM predicted the global IT Services

Tata Consultancy Services Limited

Outlook

In its Strategic Review 2011, NASSCOM predicted the global IT Services spend to increase to $684.0 Bn by 2014 from current levels of $574.0 Bn. BPO spending is also expected to grow to $201.5 Bn by 2014. Spending on both IT Offshoring and outsourcing is also likely to support the growth in overall spending in IT services. The following charts show the predicted growth in the IT Services and BPO spend over 2010P-2014E periods.

IT Services Spend CAGR 4.5% 700.0 684.0 600.0 574.0 500.0 2010P 2014E
IT Services Spend
CAGR
4.5%
700.0
684.0
600.0
574.0
500.0
2010P
2014E

Source: Nasscom, Microsec Research

BPO Spend CAGR 6.3% 300.0 201.5 150.0 158.0 0.0 2010P 2014E
BPO Spend
CAGR
6.3%
300.0
201.5
150.0
158.0
0.0
2010P
2014E

Among the concerns over visa issues and adverse geopolitical environment in Europe, a short lived slow down may be witnessed in the industry. However, the industry body expects a growth of 16-18% in IT exports from India. According to NASSCOM president Mr. Som Mittal, “The US private sector is doing reasonably well. So, we are not too worried. The problem is in the macro-economic scenario and unemployment. There are also concerns over the debt situation in Europe and whether tax rates will go up. But, by and large, the private business is doing well. So we will not revisit our forecast, unless there is a major economic upheaval.”

Our view coincides with the industry body. We believe that a large part of overall growth of the sector will be contributed by major Indian IT exporters. As a result, our view remains positive on the sector. Among the top four players – TCS, Infosys Ltd (Infosys), Wipro Ltd (Wipro), and HCL Technologies Ltd (HCL), TCS being the largest could capture the largest part of the growth.

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Analyst: npdaga@microsec.in

I NV E ST M EN T TH E SI S Tata Consultan cy Services Li
  • I NV E ST M EN T TH E SI S

Tata Consultan cy Services Li mited

FY2008

T otal Income

`2 2,619 Crores Net Profit ` 5,026 Crores

FY 2009

Total Income

`27,8 13 Crores

Net

Profit

`5,31 1 Crores

FY2010

Total Inco me `30,029 Cr ores

Net Prof it `7,001 Cr ores

FY2011

To tal Income `37 ,325 Crores N et Profit `9, 068 Crores

S IZ E D OE S M AT TE R ‐ 10 ‐ Analyst: n pdaga@micro
S IZ E D OE S M AT TE R
‐ 10 ‐
Analyst: n pdaga@micro sec.in
25 June 20 11
Microsec Re search
Tata Consultancy Services Limited Investment Thesis - Size does matter TCS is the country’s largest software

Tata Consultancy Services Limited

Investment Thesis - Size does matter

TCS is the country’s largest software exporter. The company’s top line is more than 35% higher than its nearest competitor Infosys while its net profit is ~33% more than that of Infosys. The gap is continuously widening between these two entities since last seven quarters. TCS is present across the globe with 145 offices in 42 countries and 106 delivery centers in 20 countries. In addition, TCS’ broad service offerings and integrated solutions help it to provide one stop solutions to its customers’ needs. The company’s services portfolio consists of Application Development and Maintenance, Business Intelligence, Enterprise Solutions, Assurance, Engineering and Industrial Services, IT Infrastructure Services, Business Process Outsourcing, Consulting, and Asset Leverages Solutions. Through these services, TCS captures needs of all its customers, in different verticals, spread across the globe. The company’s diversified operations and large size helped it to bag healthy growth in business volumes over last several quarters. In addition, these attributes coupled with TCS’ healthy balance sheet helped it successfully sail through the headwinds such as exchange fluctuations and pricing pressures. A brief overview of contributors in the company’s top line growth is shown in the following Exhibit.

16.0% Q-o-Q Revenue growth contributors 12.0% 8.0% 4.0% 0.0% -4.0% -8.0% -12.0% Pricing Volume Efforts Exchange
16.0%
Q-o-Q Revenue growth contributors
12.0%
8.0%
4.0%
0.0%
-4.0%
-8.0%
-12.0%
Pricing
Volume
Efforts
Exchange Differences
Aggregate Revenue Growth
Source: Company Data, Microsec Research

As represented in the Exhibit above, TCS’ revenue growth in last eight quarters was largely driven by strong volumes, even on a large base. This factor provided the company enough muscle to counter with the sharp sequential appreciation of ` against $ during Q3 FY2010, Q4 FY2010, Q1 FY2011, and Q3 FY2011. We believe volumes will remain the key contributor in TCS’ revenue growth in the upcoming quarters as well. In addition, the top line growth in expected to be supported by an improved pricing environment. We expect a more than 20% volume growth in FY2012E and FY2013E while we expect a 1.0% and 0.5% improvement in prices during FY2012E and FY2013E respectively.

Global Network Delivery Model TM adds value

To enhance efficiency and better cater the customer needs, TCS established a unique Global Network Delivery Model TM (GNDM TM ). With the model, the company creates value for its customers by helping them optimize their operations while pursuing new growth initiatives. Under GNDM TM TCS delivers services to clients through its services centers spread across India, China, Europe, North America, and Latin America. The following Exhibit depicts TCS’ solution centers across the globe.

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Analyst: npdaga@microsec.in

Tata Consultan cy Services Li m ited Source: Company Dat a Across th e globe ser

Tata Consultan cy Services Li mited

Source: Company Dat a
Source: Company Dat a

Across th e globe ser vice centers

equip TCS

with better c ompetency t o bag local

IT projects i n the

respectiv e locations.

Moreover, G NDM TM ensur es ‘One Glob al Service S tandard’ thr ough collabo ration

of project s and levera ging assets.

Non linea r initiatives – additional le vers for the g rowth

As a part of its strate gic growth i nitiatives, TC S also focus es on tappin g lucrative n on linear bus iness

opportun ities. The att ractiveness

drive rev enue growt h without a

of the initiati ves lies in th e attribute t hat they allo w the compa ny to proportiona l increase i n number o f employee s. These se rvices

primarily

include clou d based sof tware servic es, managed

services a nd accelerat ed solutions.

TCS’

non-linea r offerings a re currently

divided into

three segm ents, which

are depicte d in the foll owing

graph. No n linear acti vities, we bel ieve, will pro vide levers t o future
graph. No n linear acti vities, we bel ieve, will pro vide levers t o future grow th of the co mpany.
Financial
Solutions he lp global fin ancial institu tions to
enhance
competitive ness in capit al markets,
banking
iON
and insu rance dom ains using
wide produ cts and
services
portfolio of
TCS. The co mpany
offe rs these
Platfo rm
services
under the
brand TCS
BaNCS in a bout 80
base d
BPO
countries . BaNCS co nsists of
2 7
modules
to
cater
Fina ncial
different
lines
of
b
usinesses
a cross
the
financial
Solu tions
industry.
The
segme nt had 271
active client s at the
end of FY 2011.
Source: Co mpany Data, M icrosec Resea rch
The Platf orm based
Business Pro cess Outsou rcing (BPO)
represents
a new busin ess model,
under
which, TC S executes b usiness proc esses of cus tomers at its own technol ogy platform . The service , also
known as
Process Clo uds, provide s a combina tion of IT, i nfrastructure
and BPO se rvices at a
single

point. Wit h this, the c ompany offer s end-to-end business pr ocess execut ion to clients through:

A nalytics

  • F inance and A ccounts (F&A )

  • H uman Resou rce Outsourc ing (HRO), a nd

  • P rocurement

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Analyst: n pdaga@micro sec.in

Tata Consultancy Services Limited TCS launched iON, a 3 generation Service Delivery Model, in 2011. Embraced

Tata Consultancy Services Limited

TCS launched iON, a 3 rd generation Service Delivery Model, in 2011. Embraced with Cloud Computing, it is the world’s first fully integrated IT solution for Small and Medium Businesses (SMBs). The product, pre configured with hardware, network and software, caters to all the IT needs of SMBs without investing significantly in the IT assets. In addition, iON, using pay-per-use business model, offers easy scalability at an affordable cost. Furthermore, the product is supported by business, technical and consultancy services. TCS offers iON to more than 150 SMBs and has created eco-system of over 90 Cloud Services Partners across India to provide impeccable services to clients.

Non linear services, with above average top line expansion vis-à-vis overall revenues, will provide extra push to TCS’ performance, in our view.

Customer centric organizational structure aids to margins

In the gloomy scenario of late 2008, when global financial crisis put forth the global slowdown, it was tough to maintain growth as well as profitability. Consequently, the corporate went on streamlining and reorganizing their businesses to limit the impact of the same on their businesses. TCS, being on the same side, rolled out a customer centric organizational structure in 2008:

  • To curb the potential loss of agility, which could have outgrown its structure

  • To focus on the right sectors for the future growth

Tata Consultancy Services Limited TCS launched iON, a 3 generation Service Delivery Model, in 2011. Embraced

Source: Company Data, Microsec Research

The structure while focusing on customer satisfaction enabled TCS to provide agility through reorganization of the company’s business into multiple small operating units. Each of these units pursues growth strategies in respective domain through its own resources. This factor helps these units to increase their business at best pace with expertise and focus. Moreover, the units, consisting of ~3,000 – 14,000 employees, have to manage their own costs and are liable for the profitability.

TCS witnessed the effectiveness of the structure in last two years, which helped it to exercise effective utilization of various operational levers and subsequently streamline operating costs. In addition, the company reported healthy improvement in utilization levels while keeping the attrition at an industry

13

Analyst: npdaga@microsec.in

Tata Consultancy Services Limited low level. Consequently, the company registered continued improvement in margins over FY2010

Tata Consultancy Services Limited

low level. Consequently, the company registered continued improvement in margins over FY2010 and FY2011. As a large employee base helps TCS to keep enough human resource buffer to cater the future growth, its management indicated the utilization levels to remain high in the upcoming quarters as well. With this, we believe that the company’s current margins are sustainable. However, a tax payment related to previous years may affect TCS’ post tax profits in FY2012E. We factored in the same and assumed an effective tax rate at 23.0%, which is 640 bps higher than FY2011, for FY2012E.

R&D and innovation provides edge over competition

In order to keep pace with the ongoing developments in industry, TCS provides a strong focus on Research and Development (R&D) activities. On one side, R&D helps the company to meet the current customer needs with innovative offerings, on the other it helps to prepare for the upcoming changes in the industry. Innovation differentiates TCS’ offerings from peers and acts as an edge over competition while applying for a new deal.

Additionally, TCS believes in promoting the culture of recognizing inventions within the company. In line with this, the company formed a dedicated Intellectual Property Recognition (IPR) cell during FY2011. Key functions of the cell will include formation of an effective portfolio of IP assets. At the end of FY2011, TCS was granted 68 patents while the company has filed more than 448 patents in different jurisdictions. We believe that the future oriented patents could support TCS’ performance in the upcoming quarters.

Continued dividend payments add on to stock returns

In order to provide value returns to its shareholders, TCS from more than 25 consecutive quarters is providing dividends. Of the total cash generated since FY2005, the company has distributed 48% as dividends. The pictorial presentation of sharing of cash generated from FY2005 is as follows:

Dividends

11,937

Sharing of Cash Generated since FY2005 (in ` Crore) Capital Expenditure 7,451 Acquisitions 5,566
Sharing of Cash Generated since FY2005 (in ` Crore)
Capital
Expenditure
7,451
Acquisitions
5,566

Source: Company Data, Microsec Research

We believe that TCS will remain committed to reward the shareholders in future as well. With this, the dividends are expected keep on additions to investors’ return kitty, going forward.

14

Analyst: npdaga@microsec.in

Tata Consultancy Services Limited Peer Group – TCS versus Infosys – ‘The Bellwether Race’ Considering TCS’

Tata Consultancy Services Limited

Peer Group – TCS versus Infosys – ‘The Bellwether Race’

Considering TCS’ size, its presence across the globe, and market capitalization, we selected Infosys Technologies Ltd (Infosys), its nearest competitor, in the peer group. These two account for more than 15% of the total Indian IT exports. Furthermore, the giants are the trendsetters for the entire industry as well. A brief overview of both the companies’ operations is reflected below:

16.0% Revenues Growth over the period 12.0% 8.0% 4.0% 0.0% ‐4.0% INFY TCS
16.0%
Revenues Growth over the period
12.0%
8.0%
4.0%
0.0%
‐4.0%
INFY
TCS
20.0% PAT Growth over the period 15.0% 10.0% 5.0% 0.0% ‐5.0% ‐10.0% INFY TCS
20.0%
PAT Growth over the period
15.0%
10.0%
5.0%
0.0%
‐5.0%
‐10.0%
INFY
TCS
200,000 Headcount over the period 175,000 150,000 125,000 100,000 75,000 INFY TCS
200,000
Headcount over the period
175,000
150,000
125,000
100,000
75,000
INFY
TCS
Attrition over the period 16.0% 13.0% 10.0% INFY TCS
Attrition over the period
16.0%
13.0%
10.0%
INFY
TCS
30.0% PAT Margins over the period 27.0% 24.0% 21.0% 18.0% 15.0% INFY TCS
30.0%
PAT Margins over the period
27.0%
24.0%
21.0%
18.0%
15.0%
INFY
TCS
33.0 PE (x) over FY2011 30.0 27.0 24.0 21.0 18.0 15.0 INFY TCS
33.0
PE (x) over FY2011
30.0
27.0
24.0
21.0
18.0
15.0
INFY
TCS
64.0% Returns over FY2011 50.0% 36.0% 22.0% 8.0% ‐6.0% ‐20.0% INFY TCS Source: Company Data, Microsec
64.0%
Returns over FY2011
50.0%
36.0%
22.0%
8.0%
‐6.0%
‐20.0%
INFY
TCS
Source: Company Data, Microsec Research, Bloomberg
2,500.0 Market Capitalization (in ` Bn) over FY2011 2,200.0 1,900.0 1,600.0 1,300.0 INFY TCS
2,500.0
Market Capitalization (in ` Bn) over FY2011
2,200.0
1,900.0
1,600.0
1,300.0
INFY
TCS

We analyzed the performance of Infosys and TCS based on the following five fundamental parameters over the last twelve quarters’ reported numbers:

  • 1. Sequential growth in Revenues

15

Analyst: npdaga@microsec.in

Tata Consultancy Services Limited 2. Q-o-Q increase in Net Profit 3. Total Headcount 4. Attrition Levels

Tata Consultancy Services Limited

  • 2. Q-o-Q increase in Net Profit

  • 3. Total Headcount

  • 4. Attrition Levels

  • 5. PAT Margins

We found that TCS witness a sharp continuous improvement in performance from Q2 FY2009. The implementation of customer centric organizational structure started providing fruits from that period. While on the revenue growth front, the company outperformed Infosys in last three quarters, rise in profits outperformed the nearest peer in most of the times during last eight quarters. The company’s PAT Margins, lagging 547 bps in Q1 FY2008, are now slightly higher than Infosys. The headcount and attrition gap also reflects TCS’ superiority over Infosys.

We also analyzed TCS’ stock performance over FY2011, which represents the period when TCS outperformed Infosys on most of the fundamental factors. For this, we selected three parameters:

  • 1. Price-to-Earnings (PE) Multiple

  • 2. Stock Returns

  • 3. Market Capitalization

The gap in PE multiple, between Infosys and TCS, narrowed down, to almost ‘nil’, during FY2011. Furthermore, TCS provided whopping returns of 48.5% over FY2011 vis-à-vis Infosys’ 22.6%. Additionally, the company’s market capitalization, just 3.1% higher than that of Infosys at the beginning of the year, had a 24.5% premium over Infosys at the end of the year.

Based on above factors coupled with likely sustainability of the TCS’ growth momentum, we believe that it is all set replace Infosys as the Bellwether of the Industry.

Peer Group Table

Particulars

TCS

Infosys

Net Sales

37,324.51

27,501.00

Growth (%)

24.30%

20.93%

EBITDA

11,178.36

8,958.00

EBITDA Margins (%)

29.95%

32.57%

Net Profit

9,068.04

6,823.00

Net Profit Margins (%)

24.30%

24.81%

Net Profit Growth (%)

29.53%

8.89%

EPS

46.27

119.41

BVPS

124.69

477.85

P/E

25.95

23.23

P/BV

9.63

5.81

EV/EBITDA

20.37

15.83

RoE

37.2%

25.0%

Source: Companies' Data, Microsec Research

16

Analyst: npdaga@microsec.in

Tata Consultancy Services Limited Key Management Personnel TCS is led by well educated and highly qualified

Tata Consultancy Services Limited

Key Management Personnel

TCS is led by well educated and highly qualified professionals and industry veterans. The company’s management helped it ride through the sub-prime crisis waves successfully by implementing right strategies and frameworks at the right time. A glimpse of TCS’ management is depicted in the exhibit below:

Tata Consultancy Services Limited Key Management Personnel TCS is led by well educated and highly qualified

Source: Company, Microsec Research

Continuing with its Customer Centric Organizational Structure, TCS recently made significant changes in the same. Under this, the company’s CEO Mr. N. Chandrasekaran created small group of eight leaders to oversee work of its multiple business units. These leaders will directly report to the CEO. The eight units are further aligned 25 operating units. According to Mr. Kedar Shirali, Director of Investor Relation, “This is not a consolidation…existing P&Ls have been retained; the empowerment, ownership and accountability levels of the ISU-heads remain unchanged. In addition, stack owners will be measured on the synergistic benefits expected from the alignment, such as improved win-ratios and various operational metrics.” The management’s continued review and customer centric approach will remain instrumental in TCS’ future performance, in our view.

17

Analyst: npdaga@microsec.in

Tata Consultancy Services Limited Valuation We adopted a comparable valuation method to valu e TCS based

Tata Consultancy Services Limited

Valuation

We adopted a comparable valuation method to value TCS based on Price-to-Earnings (P/E) multiples. Historically, the company traded on a five year average P/E multiple of 24.2x. This reveals a discount to the peer group average P/E of 25.4x for the same period. In the longer run, we expect the company to trade at a premium over the peer group average P/E based on its outperformance. With this, we anticipate the P/E gap, of TCS and Industry to stand at 0.5x in subsequent years. As a result, to arrive at a target P/E multiple for TCS we applied a 19% discount to five year average P/E of peer group. Adding the premium, this resulted in a targeted P/E multiple of 21.1x for the company, which on FY2013E EPS of `65.88, reflects a target price of `1,388.70, inclusive of dividend payments, for the stock. Our target price translates a 22.2% upside over TCS’ current stock price. On an annualized basis, this translates into returns of 12.7%. Following table represents the sensitivity of our target price to variation of target PE multiples and EPS levels.

PE
PE
EPS
EPS

1,388.70

19.08

20.08

21.08

22.08

23.08

 
  • 63.88 1282.60

1218.70

1346.50

  • 1410.40 1474.30

  • 64.88 1302.70

1237.80

1367.60

  • 1432.50 1497.40

65.88

1256.90

1322.80

 
  • 1454.50 1520.40

 
  • 66.88 1342.90

1276.00

1409.70

  • 1476.60 1543.50

  • 67.88 1362.90

1295.10

1430.80

  • 1498.70 1566.60

Source: Microsec Research

PE Bands

2,000.00 1,600.00 1,200.00 800.00 400.00 ‐ 18.0 x 21.0 x 24.0 x 27.0 x CMP
2,000.00
1,600.00
1,200.00
800.00
400.00
18.0 x
21.0 x
24.0 x
27.0 x
CMP

Source: Microsec Research, Bloomberg

18

Analyst: npdaga@microsec.in

Tata Consultancy Services Limited Key Risks TCS’ efforts to adapt the ongoing changes in glob al

Tata Consultancy Services Limited

Key Risks

TCS’ efforts to adapt the ongoing changes in global environment are commendable. In addition, the company has developed a Enterprise-wide Risk Management program to address various strategic, operational, financial, and compliance-related risks. However, there are some external factors which could impact TCS’ performance in the near term, which may lead to a downward revision in our share price. These factors are depicted below.

  • Geo-political environment in Europe, especially in Greece, and Middle East remains challenging. While Greece is on the verge of defaulting, anti-government movements in Middle East keep the business environment dull. As a large share of TCS’ revenue pie comes from these geographies, these factors may negatively impact its revenue growth.

  • Visa issues in the US emerged could also impact TCS’ performance. As the rejection rate of Visas in the US has increased significantly, it may force the company to hire local talent for servicing its customers. This factor is likely to be unfavorable for TCS’ cost benefit structure and subsequently can trim its bottom line growth.

  • Currency movements continue to remain a key driving force of the company’s performance. Appreciation of ` against other global currencies adversely affect its performance whereas depreciation of the same remains favorable. As a result, a higher than expected appreciation in the `, particularly against $, will impact TCS’ overall performance adversely in our view.

Although these factors may impact the performance of TCS in short to medium term, the long term prospects of the company remain intact. The current bailout package for Greece by IMF and sanction to adopt austerity measures may improve the situation in Europe. Furthermore, the need for cost cutting can even pose some new business opportunities. The company’s GNDM TM model is likely to help it manage balance with US visa issues. We believe that TCS’ large size, diversified geographical presence, and revenues’ spread across various industry verticals will remain supportive in countering these risks.

19

Analyst: npdaga@microsec.in

Tata Consultancy Services Limited Financial Statements Income Statement (Quarterly) Q1 11 Q2 11 Q3 11 Q4

Tata Consultancy Services Limited

Financial Statements

 

Income Statement (Quarterly)

Q1 11

 

Q2 11

Q3 11

Q4 11

Q1 12 E

Q2 12 E

Q3 12 E

Q4 12 E

Net Revenues

8,217.28

9,286.39

9,663.35

10,157.49

10,652.71

11,533.74

11,957.87

12,292.04

Salaries and Wages

3,039.05

3,411.19

3,552.23

3,723.63

4,034.95

4,290.98

4,326.09

4,346.56

Overseas business expenses

1,253.74

1,390.40

1,405.57

1,479.50

1,544.64

1,672.39

1,733.89

1,782.35

Other Operating Expenses

1,514.99

1,708.63

1,805.89

1,861.33

1,970.75

2,133.74

2,212.21

2,274.03

EBIDTA

2,409.50

2,776.17

2,899.66

3,093.03

3,102.37

3,436.63

3,685.68

3,889.10

Depreciation and Amortization

161.53

172.46

188.39

212.88

204.73

213.72

222.99

232.41

EBIT

2,247.97

2,603.71

2,711.27

2,880.15

2,897.64

3,222.91

3,462.69

3,656.69

Interest

2.68

15.28

4.87

3.65

1.87

1.87

1.87

1.87

Other Income

95.46

 

70.75

194.21

243.58

106.53

115.34

119.58

122.92

Profit Before Taxes

2,340.75

2,659.18

2,900.61

3,120.08

3,002.30

3,336.37

3,580.40

3,777.74

Provision for Taxes:

402.80

460.14

504.14

463.75

690.53

767.37

823.49

868.88

Net Profit before Tax & MI

1,937.95

2,199.04

2,396.47

2,656.33

2,311.77

2,569.01

2,756.91

2,908.86

Share of Profits of Associates

0.30

-

-

-

-

-

-

-

Minority Interest

31.58

 

29.83

26.64

33.40

28.90

32.11

34.46

36.36

Net Profit after Tax & MI

1,906.07

2,169.21

2,369.83

2,622.93

2,282.87

2,536.89

2,722.44

2,872.50

Diluted EPS

9.74

11.08

12.08

13.43

11.66

12.96

13.91

14.68

 

Income Statement (Annual)

FY2011A

FY2012E

FY2013E

 

Balance Sheet (Annual)

FY2011A

FY2012E

FY2013E

Net Revenues

37,324.51

 

46,436.36

55,875.90

Shareholders' Funds

24,504.81

34,919.52

47,813.91

Salaries and Wages

13,726.10

16,998.58

20,105.86

Minority Interest

458.17

590.00

753.22

Overseas business expenses

5,529.21

6,733.27

8,032.16

Loan Funds

74.80

74.80

74.80

Other Operating Expenses

6,890.84

8,590.73

10,267.20

Deferred Tax Liabilities

109.49

109.49

109.49

 

EBIDTA

11,178.36

14,113.78

17,470.69

TOTAL FUNDS EMPLOYED

25,147.27

35,693.81

48,751.42

Depreciation and Amortization

735.26

873.85

1,008.15

Fixed Assets

5,716.27

6,748.48

8,029.67

 

EBIT

10,443.10

13,239.93

16,462.53

Goodwill (On Consolidation)

3,232.00

3,232.00

3,232.00

Interest

26.48

7.48

7.48

Investments

1,762.67

1,762.67

1,762.67

Other Income

604.00

464.36

502.88

Deferred Tax Assets (Net)

160.18

160.18

160.18

Profit Before Taxes

11,020.62

13,696.81

16,957.94

Net Current Assets

14,276.15

23,790.48

35,566.91

Provision for Taxes

1,830.83

3,150.27

3,900.33

TOTAL USES OF FUNDS

25,147.27

35,693.81

48,751.42

Net Profit before Tax & MI

9,189.79

10,546.54

13,057.61

 

Share of Profits of Associates

0.30

-

-

 

Cash Flow (Annual)

 

FY2011A

FY2012E

FY2013E

Minority Interest

121.45

131.83

163.22

Operating Profit before WC change

11,042.75

14,570.66

17,966.09

Net Profit after Tax & MI

9,068.04

10,414.71

12,894.39

Cash Generated From Operations

8,915.09

12,671.58

16,103.02

Diluted EPS

46.27

53.21

65.88

Operating Cash Flow

6,638.09

9,521.31

12,202.70

Investing Cash Flow (1,531.25) (1,906.06) (2,289.34)

Investing Cash Flow

(1,531.25)

(1,906.06)

(2,289.34)

Financing Cash Flow

(4,658.90)

-

-

Cash Balance at beginning

1,024.37

1,502.59

9,117.84

Net increase / (decrease) in cash

447.94

7,615.25

9,913.35

Exchange Differences

 

30.28

-

-

Deposits (maturity over 3 months)

5,849.38

5,875.50

5,875.50

Restricted Cash

26.12

-

-

Cash carried to BS

 

7,378.09

14,993.34

24,906.69

  • Source: Company Data, Microsec Research

  • RoE is calculated on Closing Basis

  • All data in ` Crores unless specified

  • Shaded part reflects estimates

20

Analyst: npdaga@microsec.in

Tata Consultancy Services Limited Microsec Research: Phone No.: 91 33 30512100 Email: microsec_research@microsec.in Ajay Jaiswal: President,

Tata Consultancy Services Limited

Microsec Research: Phone No.: 91 33 30512100

Email: microsec_research@microsec.in

Ajay Jaiswal: President, Investment Strategies, Head of Research: ajaiswal@microsec.in

Fundamental Research

Name

Sectors

Designation

Email ID

Nitin Prakash Daga

IT, Telecom & Entertainment

AVP-Research

npdaga@microsec.in

Naveen Vyas

Midcaps,Market Strategies

AVP-Research

nvyas@microsec.in

Nitesh Goenka

BFSI,Metal & Mining

Sr. Research Analyst

ngoenka@microsec.in

Abhisek Sasmal

BFSI

Research Analyst

asasmal@microsec.in

Sutapa Roy

Economy

Research Analyst

s-roy@microsec.in

Gargi Deb

Agriculture & Pharma

Executive Research

gdeb@microsec.in

Ravi Gupta

Midcaps

Executive Research

rgupta@microsec.in

Technical & Derivative Research

 

Vinit Pagaria

Derivatives & Technical

VP

vpagaria@microsec.in

Ranajit Saha

Technical Research

Sr. Manager

rksaha@microsec.in

Institutional Desk

Rajiv Lilaramani

Institutional Equities

Sr. Manager

rlilaramani@microsec.in

Dhruva Mittal

Institutional Equities

Manager

dmittal@microsec.in

PMS Division

Siddharth Sedani

PMS Research

AVP

ssedani@microsec.in

Sarmistha Rudra

PMS Technical

Research Analyst

srudra@microsec.in

Research: Financial Planning Division

 

Shrivardhan Kedia

FPD Products

Manager Research

skedia@microsec.in

Research-Support

Subhabrata Boral

Research Support

Executive

sboral@microsec.in

MICROSEC RESEARCH IS ACCESSIBLE ON BLOOMBERG AT <MCLI>

Rating Scale

Recommendation

Expected absolute returns (%) over 12 months

Strong Buy

>20%

Buy

between 10% and 20%

Hold

between 0% and 10%

Underperform

between 0% and -10%

Sell

< -10%

21

Analyst: npdaga@microsec.in

Tata Consultancy Services Limited ‐ 22 ‐ Analyst: npdaga@microsec.in

Tata Consultancy Services Limited

22

Analyst: npdaga@microsec.in

Tata Consultancy Services Limited Disclaimer The investments discussed or recommended in this report may not be

Tata Consultancy Services Limited

Disclaimer

The investments discussed or recommended in this report may not be suitable for all investors. Investors should use this research as one input into formulating an investment opinion. Additional inputs should include, but are not limited to, the review of other. This is not an offer (or solicitation of an offer) to buy/sell the securities/instruments mentioned or an official confirmation. Microsec Capital Limited is not responsible for any error or inaccuracy or for any losses suffered on account of information contained in this report. This report does not purport to be offer for purchase and sale of share/ units. We and our affiliates, officers, directors, and employees, including

persons involved in the preparation or issuance of this material may: (a) from time to time, have long or short positions in, and buy or sell the securities thereof, of company (ies) mentioned herein or (b) be engaged in any other transaction involving such securities and

23

earn brokerage or other compensation discussed herein or act as advisor or lender I borrower to such company (ies) or have other

potential conflict of interest with respect to any recommendation and related information and opinions. The same persons may have acted upon the information contained here. No part of this material may be duplicated in any form and/or redistributed without Microsec Capital Limitedprior written consent.

Analyst: npdaga@microsec.in