TCS's premium valuations vis-a-vis Infosys to continue

The increase in pricing and margins, along with good traction in the BFSI (banking, financial services and insurance)/manufacturing and Latin American markets, were the highlights of Tata Consultancy Services’s (TCS) results for the quarter ended December. Once again, the company managed to beat Street expectations on the revenue, as well as the net profit fronts. Contrary to expectations of flattish earnings before interest, tax, depreciation and amortisation (Ebitda) margins, the company reported sequential margin expansion of 53 basis points at 28.9 per cent, partly helped by strong employee utilisation of about 81 per cent (excluding trainees).

Muted volume growth of 1.25 per cent, against expectations of three per cent, however, was a disappointment. The management attributed the sudden drop in volume growth to unexpected furloughs (temporary stop in spending) in the BFSI space. Furloughs are regular in the manufacturing verticals of information technology companies. Despite this setback, the BFSI and manufacturing verticals grew at decent rates of 3.5 per cent and 5.8 per cent, respectively, on sequential basis, indicating the inherent strength of TCS’s business. The management believes this is a one-time blip; it continues to be confident of future growth. The revenue growth was supported by a 130-basis point sequential increase in constant currency pricing (Infosys’s pricing grew by 180 basis points), while the net profit was boosted by higher-than-expected other income of Rs 220 crore, leading to 1.1 per cent sequential growth, against Street expectations of a four per cent decline. The company expects to perform better this year, compared to 2012. TCS has been recording upticks in discretionary spends and is ruling out any delay in decision-making by clients.

While both TCS and Infosys reported better-than-expected results, Infosys (excluding the Lodestone acquisition) outperformed TCS on the volume and pricing gains fronts, leading to higher revenue growth for Infosys. However, analysts believe to warrant a significant re-rating, Infosys would have to deliver good results on a consistent basis.

Currently, TCS trades at a 10 per cent premium to Infosys, a trend expected to sustain. The premium valuations are supported by TCS’s consistent performance in the past quarters. The TCS management is confident of beating the upper end of the National Association of Software and Services Companies’ growth projection of 11-13 per cent in FY13 and is positive on the outlook for FY14. It expects the BFSI and retail verticals to fare well and is focusing on reducing volatility in revenues from India. However, these positives appear to be priced on current valuations, limiting significant upsides in the near-term, believe analysts.