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TCS: The first impression!

Oct 14, 2004

Performance Summary
TCS announced its results yesterday, reporting strong YoY growth for the first half of FY05. Noticeably, the company has crossed the US$ 1 bn revenue mark in the first half itself. However, relatively higher rise on the expenditure front has led to a dip in operating margins.

Financial performance (US GAAP Consolidated): A snapshot
(Rs m) 1HFY04 1HFY05 Change
Sales 32,191 45,643 41.8%
Expenditure 24,339 35,893 47.5%
Operating profit (EBIT)** 7,852 9,749 24.2%
Operating profit margin (%) 24.4% 21.4%  
Other income 215 1,634 661.3%
Profit before tax 8,067 11,383 41.1%
Equity in net earnings of affiliates 73 16 -78.1%
Minority interest (55) (144)  
Tax 1,259 2,525 100.6%
Profit after tax/(loss) 6,826 8,730 27.9%
Net profit margin (%) 21.2% 19.1%  
No. of shares 455.5 480.1  
Diluted earnings per share* (Rs) 28.4 36.4  
P/E ratio (x)   30.2  
* annualised; ** including depreciation

What is the company’s business?
TCS is the largest software company in Asia and has the distinction of becoming the first Indian software company to have cross the coveted US$ 1 bn revenue mark (in FY03). The company has a wide range of offerings and caters to industries like BFSI, manufacturing, telecom, and retail. TCS was one of the pioneers of the much-acclaimed global delivery model and has the largest employee base in the Indian software sector.

What has driven performance?
  • Volume growth drives revenues: Stable billing rates and strong growth in volumes has helped TCS report a robust topline growth for both 2QFY05 and 1HFY05. For the second quarter, revenues and profits have grown sequentially by 14% each, which is almost at par with sequential growth numbers reported by its peer, Infosys. While no specific details are available, as per the US GAAP consolidated numbers, we believe that a strong growth in consultancy revenues (around 95% of revenues) have helped topline growth for TCS. The company added 52 clients in the quarter.

  • Employee additions suppress margins: A relatively stronger rise in cost of revenues has led to a fall in TCS’ margins in the first half. The company hired a net of 3,974 employees during this period and this seems to have resulted in a rise in cost of revenues. Notably, in the last five quarters, this is the fastest addition to manpower and indicates a strong demand growth that the company is anticipating in the future. However, due to the fact that TCS continues to derive a large portion (63%) of its revenues from onsite services, margins might be further impacted going forward.

  • Net profits: Apart from the fall in operating margins, a high tax liability has lowered net profit growth during 1HFY05. However, a large rise on the other income front seems to have balanced the equation.

    What to expect?
    At the current price of Rs 1,098, the stock is trading at a P/E multiple of 30.2 times annualised 1HFY05 earnings. While valuations look stretched from a medium term perspective when compared to Infosys, the fact that TCS is likely to be one of the key beneficiaries of the outsourcing opportunity cannot be ignored.


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