1QFY13: TCS v/s Infosys - Views on News from Equitymaster

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1QFY13: TCS v/s Infosys

Aug 24, 2012

In line with FY12 results, the 1QFY13 performances of Tata Consultancy Services (TCS) and Infosys seemed to reveal different faces of the current IT sector situation. While Infosys continued to disappoint investors, TCS carried on with its positive momentum.

But is it all gloom and doom for Infosys? And is it all hunky-dory for TCS? Or do we need to read between the lines? Let's drill down and take a closer look at the operational parameters of these companies.

TCS (Tata Consulting Services)

For the past year ending August 23, 2012, TCS' stock is up 35%, and is currently trading at a P/E of 23 times its trailing 12 months (TTM earnings). 1QFY13 sequential quarterly revenue growth is up 3% in USD terms, and more importantly, there is a 5.3% volume growth which brought many smiles to investors.

However, sequential quarterly operating margin dropped by 0.2% in rupee terms as the benefit of currency depreciation was outweighed by salary hikes.

Interestingly, TCS Management states that it is not facing pricing pressure. And even though its 1QFY13 USD revenue grew at only 3% (pulled down by a pricing decline of 1%), they are confident of beating Nasscom's revenue guidance of 11-14% for the IT industry as a whole.

Thus, apparently it seems that everything is going well for TCS.

Infosys

As indicated earlier, Infosys has faced operating profit problems since last year. And accordingly, it has been punished by the market (the stock has delivered a 1 year ending Aug 23, 2012 return of only 10% compared to TCS's 35%, and is currently trading at a TTM P/E of 16x versus TCS at 23x).

It came as a shock when Infosys refrained from providing its next quarter's guidance, especially when it did so in the face of more dire situations earlier in 2002-03 and 2008-09. Investors were further alarmed when the FY13 USD revenue growth guidance was reduced to 5% from its earlier 8-10%. 1QFY13 sequential quarter USD revenues declined by 1%, although there was a volume growth of 2.7%, reflecting a pricing decline. Further, the management did not shy away from admitting that a 3% pricing decline could be assumed for all of FY13. Even worse, Infosys's operating margin declined 2%.

Based on the information outlined, apparently it seems that TCS is doing well, while Infosys is folding under pricing and other pressures.

However, we believe we should ask one fundamental question to assess TCS's future.

Will TCS be able to protect itself from market pricing pressures, and maintain its operating margin?

Let's dig deeper and see what emerges.

Pricing: We examined Infosys's 1QFY13 pricing drop of 3% more closely and discovered that a major reason was a 1-1.5% decline in contribution from its Consulting and System Integration (CSI) division, which contributes roughly 30% of Infosys's total revenues. While the CSI division commands relatively higher billing rates, by its nature, it is a discretionary spending item. This reveals that customers are reducing discretionary spending and tightening pricing. In contrast, TCS's CSI Division represents only 3% of total revenue and so was less affected.

In 2008-09, following the global market crash, the IT sector was in a similar situation. At that time all IT companies across the board, including Infosys and TCS, accepted that they would experience lower revenue growth levels. In fact, apart from Hindustan Computers Limited (HCL), no other vendors resorted to lower pricing disruption techniques.

However, the current situation is different in that TCS and other IT vendors are not prepared to accept a lower sector growth scenario. In fact, they are pushing hard to compete and grow faster.

So, pricing aggression from Infosys will surely drive a competitive response from other bigger peers including TCS. TCS's 1QFY13 realization (pricing) decline of 1% is perhaps a testimony to this fact.

Even though TCS management states it is not facing any pricing pressures, we wonder if Infosys is setting a competitive stage so that TCS and other software vendors may have to follow with lowered pricing.

Cost structure: Additionally, on the cost side, both Infosys and TCS have said that they will continue to hire fresh graduates and laterals. However, Infosys has been silent on wage hikes and TCS has suffered slightly on quarterly margins by rewarding its employees.

Both TCS and Infosys are experiencing cost pressure due to local hiring and onsite subcontracting costs, particularly in the USA, given the various visa restrictions imposed by the USA authorities.

Overall, the above microscopic analysis leads us to believe that TCS too is likely to face margin weakness due to customer pricing pressures on one side and relatively inflexible local hiring and subcontracting costs on the other.

As an investor, you may find TCS's sunny disposition attractive vis a vis Infosys. However, we see some dark clouds which may make the reality for TCS and the IT sector as a whole more chilling in the near term.

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1 Responses to "1QFY13: TCS v/s Infosys"

Ramanathan

Aug 26, 2012

1. The comparison should also consider the strategy difference between both companies. While Infosys 3.0 has been a near disaster, TCS strategy of non-linear growth and diversification seem to place it comfortably against a deep recession in US and Europe. This is also a factor that market considers while giving a premium for TCS.

2. Pricing pressure is not new to either TCS or Infy. In fact, players like HCL, Satyam, CTS play largely on price to snatch the deals away from both TCS and Infosys. Despite that, both of them are sustaining for past 5 years suggest that pricing pressure will not be a major factor to influence the revenue growth.

3. Infy suffered from a fair deal of negative publicity due to its recent HR policies and Visa misuse case in US. IT lowered the confidence of investors. Add to that, current top management of Infosys do not command the same level of respect as its earlier leaders.

4. While an overall decline seem a high possibility due to world economic condition, TCS is reasonably well placed to deal with it. I'm not saying that it will not be impacted. I only state that the impact will be lower compared to other IT majors.

So in my view - the key to survive is "diversification" to reduce the dependency on US or high-end discretionary spending. Whoever does this right, will weather this perfect storm.

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