Shares of Tata Consultancy Services Ltd (TCS) fell to their lowest level in over three years this week. They have recovered since, but even at current levels the company trades at a valuation of just 13 times trailing earnings, close to a historic low. In other words, never before has the market’s earnings growth estimate of India’s largest information technology (IT) firm been this low. With the financial sector meltdown now claiming major casualties in Europe, the earlier premise that geographical diversification would reduce the impact of the US slowdown has come unstuck. Also, TCS is among those with the largest exposure to the banking and financial sector, with about 43% of its revenues coming from this industry.
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According to German newspaper Boersen-Zeitung, TCS is interested in buying the IT solutions and services unit of Siemens AG. In a bull market, this news would have sent the stock soaring, but with the recent experience of HCL Technologies Ltd waging a bidding war with Infosys Technologies Ltd over Axon Group Plc., there are now fears that Indian firms may overbid for acquisitions in their desperation to boost revenues. Besides, Siemens’ IT business will have a very high onsite component, where margins are low, and it may take a while before the acquisition adds to the company’s earnings per share.
The fears may not be misplaced, but they’re certainly premature. To start with, it’s not even confirmed if Siemens wants to sell the business. Secondly, nothing is known about the valuation of the deal.
As far as the concerns about TCS’ exposure to the financial sector goes, it’s important to note that a number of other sectors such as manufacturing and retail have also been hit by the global slowdown. Some of the companies that pulled back on orders and caused a drop in growth for Indian IT companies in the June quarter were from non-financial sectors. One view in the market is that the risk is systemic and it doesn’t make sense to punish just one stock because it has a high exposure to one sector.
But going by valuations, that theory isn’t being bought. TCS now trades at a 25% discount to Infosys’ valuations, which is extremely high considering that historically it has traded at a 10-12% discount. True, all sectors may be hit by the slowdown, but those with a higher exposure to financial services will be impacted sooner. Given the market’s focus on near-term performance, it’s not surprising that TCS shares have been among the worst hit.
Indian manufacturing: relatively insulated from rest of the world
This column took a look on Thursday at how Indian manufacturing was doing comparatively better than markets elsewhere in the world in August, according to the Purchasing Managers’ Index (PMI).
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The September manufacturing data for the PMIs for other parts of the world are now out and the table shows India continues to not only do well in manufacturing, but also seems to have increased its lead over the rest of the world.
Perhaps more importantly, the September PMI reading for the US is the lowest since October 2001; for the Eurozone, the lowest since December 2001; for Japan, the lowest in the last six and a half years and for the global PMI, it’s the lowest since November 2001.
In other words, the PMI readings suggest that global manufacturing growth prospects are currently around the level they were at in 2001.
We can also say pretty confidently that, with the global banking sector in shambles, the services component of global gross domestic product (GDP) is also not doing too well.
Recall that in 2001, the world economy slipped into a recession, with GDP growth at 2.22%, down from 4.7% in 2000. With the 2007 global GDP growth rate at 4.9%, the extent of the slowdown so far has paralleled the tech bust during 2001-02. That’s true for the fall in the stock markets as well. The problem is that all the experts and all the research studies tell us that a banking-cum-housing bust is far worse than an industry-led recession, which implies that things could get worse. But for now, the PMI surveys show Indian manufacturing has remained relatively resilient.
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