Tata Consultancy Services Ltd’s (TCS) March quarter (Q4) results confirm the markets’ belief that Infosys Technologies Ltd’s problems are company-specific. TCS reported a 5% sequential rise in both revenue and operating profit in Q4, much better than the 2% drop in profit reported by Infosys. The markets had anticipated this. While Infosys shares had shed 12% in the preceding four trading sessions, TCS shares were flat.
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While the results are much better compared with Infosys, they are in line with Street expectations and don’t warrant any meaningful upgrade in earnings estimates. What’s more, the TCS stock has already outperformed its main competitor by a huge margin, so there’s little room for a re-rating. TCS’ shares now trade at around 27 times trailing 12-month earnings, around 10% higher than Infosys’ trailing price-earnings multiple.
Because of this unusually high valuation differential, there is a murmur on the Street that it perhaps makes more sense to invest in Infosys shares. But it’s important to note that TCS has beaten Infosys in sequential operating profit growth in seven of the last eight quarters. Since the March quarter of fiscal 2008-09 (FY09), TCS’ earnings before interest and tax (Ebit) has risen at a quarterly compounded average rate of 6.6%, more than double the Infosys growth rate (3%). The difference in operating profit margin of the two firms has narrowed to less than 100 basis points from as high as 700 basis points at the peak of the financial crisis.
While it goes without saying that TCS would have to maintain its strong financial performance to justify premium valuations, the onus really is on Infosys to start outperforming and claw back on the valuation league table.
One of the challenges for TCS would be to maintain margins at the current record levels. This has been possible largely because of high employee utilization rates of 82.4-83.8% in the last fiscal. Traditionally, utilization rates beyond the late 70s have been considered far too high and likely impediments to act on new growth opportunities. But according to the company management, this is the new normal and it’s quite comfortable operating in this range.
Further, TCS will increase wages by 12-14% for its offshore employees, which will also put pressure on margins. Some of this could get offset by increases in pricing, which is possible given the strong demand environment.
Another concern voiced by some analysts is that volumes grew by just 2.9% last quarter and that the company’s gross hiring target of 60,000 employees in FY12 doesn’t compare well with its gross hiring of 70,000 in FY11. But it must be noted that the March quarter has historically been a soft quarter and TCS’ gross hiring target hasn’t been a good leading indicator in the past.
In sum, while FY12 should be a good year in terms of revenue growth, maintaining margins would be a challenge. And unless Infosys bounces back from its own woes, TCS should continue as the most valued tech stock among the listed firms in India.
Graphics by Yogesh Kumar/Mint
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