Unlike Infosys, no spark in TCS's Q3

Some analysts believe underperformance of the TCS stock may continue

Unlike its closest peer, Infosys, which posted higher than expected numbers and forecast last week, Tata Consultancy Services (TCS) failed to deliver any surprise in its quarterly results. The company's volume growth remained flattish at 0.4 per cent, compared with Infosys' 4.2 per cent. Notably, TCS'volume growth has lagged Infosys for the first time in eight quarters.

This metric is at a multi-quarter low for TCS. Despite the seasonality, volume growth stood at 1.8 per cent in the December 2013 quarter and 1.25 per cent in the December 2012 quarter. The divergence in volume growth of both tech giants is also surprising, as the December quarter is weak for the entire sector due to a lower number of working days and furloughs.

However, TCS did well on realisation, up 2.3 per cent, leading to constant currency revenue growth of 2.5 per cent sequentially. For Infosys, realisations fell, leading to a 2.6 per cent sequential constant currency revenue growth.

The key pressure points for TCS are its insurance business (Diligenta acquisition) which is facing growth headwinds and has limited visibility in the near future, and weak energy and retail verticals. Also, the fact that TCS derives higher revenue from Europe (27.8 per cent of revenues) than Infosys (24 per cent of revenues) means the former is more impacted by adverse cross-currency moves.

While TCS numbers were largely in line with consensus estimates, most analysts remain concerned with its slowing revenue traction over the past two quarters. On profitability, too, TCS's Ebit (earnings before interest, tax) margins expanded by 20 basis points to 27 per cent, while Infosys was up 63 basis points to 26.7 per cent due to a favourable rupee and utilisation. Given TCS' high utilisation levels of 86.7 per cent, the scope for further gains in this metric is very little versus Infosys which has a utilisation rate of 82.7 per cent.

Forex gains boosted net profit for both, even as lower operating expenses boosted Infosys' profits.

The good news is both managements continue to remain confident on the deal pipeline and expect client budgets to be largely flattish, with an upside bias for CY15.

For now, the street remains more bullish on Infosys and also believes the scope for positive surprises remain higher in the case of Infosys. However, they will be keenly watching sustainability of the company's performance. If not, it might become difficult for Infosys to bridge the valuation gap with its larger peer. TCS trades at about 20 times the FY16 estimated earnings, while this number for Infosys is 17 times.