Buy TCS; target of Rs 1440: Angel Broking

Strong topline growth driven by volumes, despite rupee appreciation

TCS grew its revenues at a decent pace of 5.9% QoQ during Q4FY2007. This was mainly a result of good volume growth to the extent of 6.4% QoQ, pricing-led improvements to the tune of 89bps and productivity improvements of 44bps. However, the rupee appreciation during the quarter led to an adverse impact of around 1.9% on the topline growth, thus leading to the growth in rupee terms being slower than the dollar growth, which was impressive at 8% QoQ. TCS continues to grow its global delivery model and revenues from its global delivery centres (GDCs) accounted for 4.6% of total revenues in Q4FY2007. The company now has delivery centres in places like China, Mexico, Brazil and Latin America and in opening a new development centre in Morocco, a clear testimony to the fact that it has by far the widest global network among all the top-tier software companies. This undoubtedly gives TCS an edge over its peers, serving as a competitive differentiator.

Productivity improvements aid margins

During Q4FY2007, TCS managed to maintain its EBITDA margins at the same level as was the case in the previous quarter, in fact, actually managing a marginal expansion of 1bp. The appreciating rupee had a negative impact of 57bps on the margins, which was effectively set off through improvements in productivity and higher utilisation rates (79.6% excluding trainees in Q4FY07 Vs 78.2% in Q3FY07). Thus, TCS has clearly shown its ability to manage margins even in the face of stiff headwinds such as volatile currency movements.

Higher other income enables decent bottomline growth

TCS saw a decent 6.2% QoQ growth in its bottomline for the quarter. Other income provided a strong fillip to the bottomline growth, growing at as much as 199.5% QoQ. Thus, this was the major factor that enabled the bottomline to grow at a faster pace than the topline, even as depreciation charges and tax payments rose at QoQ rates of 29.2% and 19.7% respectively.

Outlook and valuations

TCS has hit virtually bull’s eye on our topline estimates for FY2007. While we had estimated the company to hit Rs 18,634cr, the company managed to hit Rs 18,633cr. However, on the margins front, TCS saw further fall compared with what we had originally anticipated, witnessing a 48bps fall, as compared to our estimates of a 30bps fall. On the bottomline front, the company has slightly out-performed our estimates, hitting Rs 4,132cr, compared with our estimates of Rs 4,121cr.

Going forward, we expect TCS to record a 30.5% CAGR in topline between FY2007 and FY2009, while we expect the bottomline to clock a 24.5% CAGR in that period. We expect margins to fall by around 50bps each year, mainly due to continued wage inflation. The demand environment appears strong for TCS and the company, with its ‘full-services model’ and global delivery network, appears well-positioned to reap the benefits of the strong growth expected in the global offshoring industry. Nonetheless, we believe that headwinds such as higher attrition rates, wage inflation and currency appreciation could play spoilsport in future and greater-than-expected appreciation of the rupee against the US dollar would be a downside risk to our estimates.
At the CMP, the stock trades at 19.1x FY2009E EPS. We maintain a BUY on the stock with a 12-month target price of Rs 1440.