The shares of India’s largest computer services provider, Tata Consultancy Services Ltd (TCS), had underperformed those of its closest rival Infosys Technologies Ltd by 26% since the beginning of the results season in April.
The company’s statements earlier this year about project delays by two large clients and that it hadn’t billed certain clients during project transition—akin to a pricing discount—had led to fears that its earnings growth this financial year would be substantially lower than that of its peers.
Based on the June quarter results of the two companies, the notion that TCS’ earnings this year will be much lower than that of Infosys isn’t way off base. In rupee terms, TCS’ operating profit has risen by 18.3% year-on-year, after adjusting for a change in the accounting policy on depreciation. Infosys’s operating profit rose by 39.4%, more than 20 percentage points higher than TCS’. Things get worse after accounting for other income. TCS’ profit before tax is up a mere 3.5%, while Infosys managed a 19.6% growth.
TCS had gained more from forex hedges in the previous year, and hence last year’s other income represents a relatively high base for the company. After accounting for forex losses this year, other income fell by 83% to Rs33 crore for TCS. In Infosys’ case, other income fell by 54% to Rs117 crore.
Although its profit growth rate was much lower, analysts are enthused about the statements TCS has made. It has said that most of the client-specific issues and the free transition pricing issues are behind the company. Chief financial officer S. Mahalingam says the momentum is picking up, and although this may not get entirely reflected in the September quarter, growth in the second half is likely to be much better.
While the company’s language is much more positive compared with three months ago, the results themselves hold little reason for cheer. On the positive side, revenues from the non-financial sectors grew well, and overheads such as travel were cut sharply. But overall volumes hardly grew and average realization has now fallen by 2.5% since the December quarter. One analyst says the company’s decision to relax depreciation accounting norms at this juncture is also not a good sign. The move added 80 basis points to the company’s margin (hundred basis points make one percentage point).
It’s not surprising, then, that despite the bounce back on Thursday, TCS still trades at a hefty 20% discount to Infosys based on the past price-earnings multiple.
Slow growth may impact oil price
If any proof was needed about the importance of oil prices to markets, Thursday’s action in the stock, bond and currency markets provided it. With crude oil down to around $134 (Rs5,748) a barrel, stocks soared, bond yields softened and the rupee hardened.
The day also brought another bit of good news —gross domestic product (GDP) growth in China slowed to 10.1% in the June quarter, the fourth consecutive quarter of falling growth. With growth in China, India and the US slowing, the hope is that a slowdown in demand will cool oil prices.
A research note by Lehman Brothers says, “The (Chinese) government and the PBC (People’s Bank of China) will likely maintain their tightening bias for at least two-three months. However, we do not expect the PBC to become more aggressive in monetary tightening, given already tight credit conditions and an uncertain growth outlook.” Lehman predicts 8% growth in China’s GDP next year.
Analysts have already started working out scenarios that show the impact of slowing Chinese growth. A Goldman Sachs note points to the implications on commodities of such a sharp fall in Chinese growth, indicating that coal, iron ore and aluminium will see the most limited declines, while lead, zinc and nickel will be the hardest hit.
But the jury is still out on whether China will continue to take stringent measures against inflation, especially now that the data show lower inflation in June. If it doesn’t, crude oil prices will have one more reason for remaining high, in addition to other reasons such as hurricanes, geopolitical tensions and speculation.
In the last few months, oil prices have continued to move up despite a slowing world economy, indicating that the pace of demand destruction has still not been sufficient.
During the early 1980s, global GDP growth had to fall to 0.8% in 1982 to make a dent on oil prices. With the global growth at 4.9% in 2007, that’s a long way to fall.
In fact, the remedy may be worse than the cure. That’s the dilemma the Shanghai stock market found itself in, when it broke ranks with the rest of the Asian markets and fell on Thursday.
Biocon results disappoint
It isn’t only foreign exchange losses or mark-to-market provisions that have hit biotechnology firm Biocon Ltd’s profit in the June quarter. Profit before tax, forex losses and exceptional items, too, was lower by 14% compared with the same period last year.
Actually, the results are not strictly comparable, because last year’s June quarter included revenues from the enzymes business, which it has since divested. But on the other hand, there was a jump in other income as the firm deployed the funds from the divestment.
On a like-for-like basis (not taking enzymes into account), revenues were up 7% year-on-year, with the biopharmaceuticals business, which accounts for 83% of revenues, showing revenue growth of 9%. This was despite the lack of any technical licensing fees during the quarter. In the year-ago quarter, these fees amounted to Rs16.8 crore, a significant amount. Revenues from contract research were down 2%.
The lack of revenue growth was compounded by lower Ebitda (earnings before interest, taxes, depreciation and amortization) margins, which were 21.8% in the June quarter, compared with 30.9% in the March quarter. Compared with the quarter to March—which, too, did not have any enzyme revenues—revenues are flat, but Ebitda is down 30%. Research and development and staff costs have been much higher in the June quarter. Higher capital expenditure has also resulted in increased interest charges.
Analysts continue to believe in Biocon’s potential over the longer term, as the company is able to license new molecules and diversify its business. In the short run, however, visibility on growth drivers is poor, which is why the stock has languished despite a bonus announcement.
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