Infosys pips TCS on Q3 margins

Experts feel TCS has run out of further margin levers and has to deliver consistently on revenue

Both Tata Consultancy Services (TCS) and Infosys delivered in-line set of numbers for the December 2016 quarter (Q3). Expectations from Infosys were already muted given that this quarter witnessed the impact of cancellation of the RBS deal which took away 100 basis points from its revenue growth in the quarter. TCS' numbers on the other hand were boosted by strong growth in the India business. Both companies' outlook for the last quarter of the fiscal too is on similar lines. While Infosys toned down its constant currency revenue growth guidance (at the upper end) for the third time this fiscal, TCS indicated that fourth quarter will be business as usual. Notably, TCS has posted 1.5-2 per cent revenue growth in the previous quarter of the fiscal and the trend could be similar this time around as well. Though the Street was expecting some downward revisions in Infosys' guidance, they were in for a surprise.

"Upward revision of the lower end of the guidance is a positive, which indicates that Infosys envisages better revenue visibility in the near-term, as the bottom appears to have been hit," says Harit Shah, IT analyst at Reliance Securities. This guidance would translate in a -0.2 per cent to +1.3 per cent dollar revenue growth in the on-going quarter. Some analysts term the guidance "conservative".

One area of divergence in these companies' results was their margin performance. While TCS delivered flat EBIT margin of 26 per cent, Infosys witnessed a 20 basis points improvement in this metric to 25.1 per cent backed by lower variable pay. In fact, though both the companies have maintained their targeted EBIT margin bands, analysts believe TCS might find it difficult. Ashish Chopra, IT analyst at Motilal Oswal Securities believes that driving productivity gains would help TCS offset the pricing decline and may not necessarily lead to an uptick in margins. Over the past few years, TCS has grown very profitability and experts now believe it has run out of further margin levers. This means the company has to deliver consistently on the revenue front. However, given the uncertainty around demand environment, there is limited clarity on this front as yet. Infosys on the other hand has multiple margin levers such as favorable revenue mix, scope to improve its attrition and utilisation levels. Rising thrust on automation is another driver of margins but will bear fruit only gradually.

Both the stocks fell 3-4 per cent fall on Friday. Part of this weakness can be attributed to rising concerns around implementation of stricter visa norms of their key market -- US. Though analysts are positive on both these stocks they prefer Infosys over TCS given that the higher scope for a positive surprise in Infosys' financial performance. At current levels, Infosys trades at 14 times FY18 estimated earnings or a 12 per cent discount to TCS. This discount could come down going forward as Infosys continues to deliver healthy results.