India’s largest tech services firm, Tata Consultancy Services Ltd (TCS), shares had nearly doubled from its low in early March, and hence there was ample room for a correction in valuations in case its results for the June quarter fell short of expectations. Yet, its shares are likely to rise further next Monday since the results were way ahead of street estimates. Against a forecast of a 4% sequential drop in revenues, the company reported a 0.5% growth, which is much better compared with the drop of 2.9% in Infosys Technologies Ltd Q1 revenues.
When Infosys contained the drop in both volumes and pricing at 1% last quarter, the street was quite impressed. TCS has managed to increase volumes by 3.6% and contain the drop in average price realization at a mere 0.25%. Of course, TCS performance in the March quarter was relatively weaker, with organic revenues declining by 6.4%, compared with Infosys 3.2% drop, and in that sense the growth came off a lower base. But then, given TCS relatively high exposure to the troubled auto sector as well as the banking and financial services sector, one would have expected the pain to continue. The growth in volumes and revenues, therefore, is a pleasant surprise.
On a year-on-year basis, cash flow generated from operations has risen by about 10%, despite a 24.5% increase in cash profit. Ahmed Raza Khan / Mint
What’s more, TCS has improved its operating margin by 113 basis points, compared with street expectations of a decline of about 90 basis points. This again is better than Infosys margin improvement of 57 basis points. A basis point is one-hundredth of a percentage point.
Employee costs shrank by 65 basis points thanks to an improvement in utilization. The company has gone slow on manpower addition, and thanks to the normal attrition, its employee base has decreased for the first time on a quarter-on-quarter basis. Besides, there was a large shift in work to offshore units, which too helped contain employee costs. Offshore revenues grew by 6.2% in rupee terms against the 0.5% growth in overall revenues. The company has cut costs aggressively on other fronts as well. Selling, general and administrative expenses fell by 93 basis points and expenses on travel and communication too were rationalized. The overall cost containment is rather impressive.
Any areas of concern? While the company has improved its debtor days, cash flows continue to be under some strain. On a year-on-year basis, cash flow generated from operations has risen by about 10%, despite a 24.5% increase in cash profit (net profit plus depreciation). Infosys reported an impressive 35% growth in cash flow from operations, although its cash profit grew at a lower rate of 21%. Besides, the number of active clients fell from 985 at the end of the March quarter to 933 at the end of the June quarter. Also, TCS had seven clients with annual billing of at least $100 million (Rs487 crore) at the end of the March quarter. This fell to six in the last quarter. According to the company, the drop in one client’s revenues is marginal and isn’t a matter of concern. It adds that it hasn’t lost any of its regular “annuity” clients but that the drop in the number of active clients is because of “single-project” customers, where the projects got over. Having said that, there seems to be a marginal drop in client profile, with even clients who have at least $20 million annual billing dropping from 62 to 59.
But these factors are likely to be overlooked by the markets, thanks to the impressive growth in revenue and profit. The TCS stock has risen by 95% from its lows in March and now trades at a valuation of 16.3 times estimated earnings for the current year. This represents a discount of about 12% to Infosys valuations, which is a steep improvement compared with the discount of about 30% in early March. The superior growth last quarter,to some extent, justifies the market’s preference for TCS shares in the past few months.
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