For the fourth quarter of FY10, Tata Consultancy Services Ltd (TCS) reported strong performance well ahead of ours and consensus estimates. Revenue growth of 3.1% sequentially in dollar terms was in line with our expectations. However, the growth in reported revenue was affected by unfavourable currency movements.
The company utilized various operating levers, which helped it report 19 basis points (bps) sequential and 368 bps year-on-year (y-o-y) improvement in earnings before interest, tax, depreciation and amortization margins. Further, strong other income of Rs163 crore aided net profit growth of 7.4% sequentially and 47.1% y-o-y growth. Strong growth in profits came as a surprise as the company was on an aggressive hiring spree adding 10,775 employees during the quarter. We recommend a buy on the stock, with a target price of Rs921.
TCS recorded revenue growth of 1.1% sequentially (7.9% y-o-y) backed by 4% growth in volumes. The growth in revenues was broad based and was largely driven by new service offerings, such as asset-leveraged solutions (26.4%), consulting (20.4%), assurance services (15%) and information technology outsourcing (6.2%), highlighting full-service-offering capabilities of the company. The company closed 10 large deals and added 39 new clients during the quarter. The earnings before interest and tax margin expanded by 20 bps sequentially mainly on account of improvement in productivity by 247 bps. The company also reported strong net other income of Rs163 crore, up from Rs56.9 crore in the third quarter of FY10, mainly on account of the 69% sequential increase in interest income and strong non-operating income of Rs110 crore.
Graphic: Paras Jain / Mint
Among the various verticals that registered a growth, TCS recorded a strong sequential growth of 4.6%, 4.1%, 3.7% and 3.1% in life sciences, transportation, retail and distribution and hi-tech, respectively. Though the company has started witnessing large transformational deals, the same are coming in a phased manner and will take few more quarters to witness strong ramp ups. In terms of geography, growth was led through a continued strong recovery in North America, which was up 4% sequentially, and 5.9% sequential growth in domestic revenues (won some government projects in the third quarter of FY10). The company closed 10 large deals across services and verticals comprising large deals of over $500 million and two deals of over $150 million each.
The company added 39 new clients during the quarter. Contribution from top clients grew by a substantial 83% ($519 million in FY10 against $282.7 million in FY09) on account of acquisition of Citi Global Services.
TCS had total outstanding hedge positions of around $200 million as on the fourth quarter of FY10 and is now focusing on covering exposure of smaller tenors in view of volatile currency movement.
The demand side looks optimistic as suggested by management confidence, robust hiring and peer guidance. We expect the company to deliver a revenue compounded annual growth rate of 13.7% over FY10-12, assuming 19% growth in dollar revenue and realizations fall of 600 bps on account of rupee appreciation, over the period (at rupee/dollar rate of 44.50).
The profit after tax margins would decline by 180 bps by FY12 absorbing the higher wage rate, rupee appreciation and increased effective tax rate.
Thus, the growth in earnings per share would be lower at 9.2% during the period. We have valued the stock at 22 times its estimated FY12 earnings similar to its historical average of 21 times during FY07-10 and on a par with our target price-earnings multiple of 22 times for Infosys Technologies Ltd.