TCS Ltd (Q2 FY14)

• Comprehensive beat on volume expectation; Realization corrects marginally

• Sustained broad based growth across segments; Discretionary services continue to grow well

• OPM performance better than estimate despite realization correction

• Sector-leading revenue and margin continue to impress; Rich valuations make us retain MP rating

Comprehensive beat on volume expectation; Realization corrects marginally 

The highlight of TCS’ Q2 FY14 results was the commendable volume grpwth pf 7.3%. This was materially ahead of our expectation of 6.3% growth. Impacted by cross currencies (-1.3%) and realization correction (~1%) resulted in reported dollar revenues coming in marginally ahead of expectation at US$3.34bn. Due to the material rupee depreciation, the reported rupee revenues were up 16.6% qoq to Rs210bn. Management commentary on demand environment continued to be robust especially on discretionary spends, deal closures and executable order book. Company announced eight large deals (ten deals signed last quarter) across verticals and geographies.  

Sustained broad based growth across segments; Discretionary services continue to grow well

TCS registered yet another quarter of very broad based revenue growth across all business segments – verticals, geographies and services. Amongst verticals, growth was driven by BFSI (+5.7% qoq) and Retail (+4.7% qoq). Amongst services, Enterprise solutions (+7.5% qoq), Infrastructure services (+4.5% qoq) and ADM (+3.9% qoq) were the key growth drivers. We note that the discretionary services (ERP, Consulting) have continued to grow well indicating sustained pick-up. Amongst the geographies, developed markets (Continental Europe +19.3% qoq, UK +7.3% qoq and US +3.7% qoq) were the key revenue drivers. India business on the other hand was weak with revenues de-growing 4% qoq in dollar terms.

OPM performance better than estimate despite realization correction

The OPM for TCS expanded 300bps qoq to 31.6% in Q2 FY14 - highest in the sector and in the company’s history. Though this was only marginally better than our expectation, it came in despite the constant currency realization correcting 95bps. Overall, key headwinds from cross currencies, realization correction and integration of low margin ALTI business were more than offset by weak rupee and operational margin improvement (30bps). A marginal beat on revenues, OPM as well as lower than expected forex losses (Rs3.8bn) resulted in PAT coming in 2% higher than expected at Rs47bn. The employee additions (+2.8% qoq) were decent with attrition remaining low at 10%.

Sector leading revenue and margin performance continues to impress; Rich valuations make us retain MP rating

TCS’ Q2 FY14 volume performance was better than the most optimistic estimate on the street. Overall, the results continue to set benchmark both in volumes and profitability for the entire sector. TCS’ broad-based expertise, superior execution and convincing pick-up in demand environment  (especially in US, Europe, BFSI segments) were key reasons for the sustained sector-leading performance. This and strong management commentary provide comforting indication on the improvement in demand scenario.  While the company’s performance continues to set new benchmarks, the P/E valuation appears to have priced in a lot of the same. We increase our estimates marginally post the beat in current quarter and also up our 9-month TP to Rs2,261 but retain MP rating.