Earning Update : TCS

Background: Started in 1968, TCS pioneered IT services exports & is India's largest exporter (FY14 rev: INR 818bn, 300,464 people). Revenue Split: North America - 55.3%, Europe - 28.7%, ROW - 15.9%. Services Mix: ADM - 41.6%, Enterprise Soln - 15.5%, Assurance Services - 8.4%, Engg, Indl - 4.7%, Infra Services - 11.9%, Global Consulting - 3.4%, Asset Lev Solns - 2.5%, BPO - 12%. Verticals mix: BFSI -42.9%, Telecom - 9.5%, Retail - 13.8%, Manufacturing - 8.5%, Hi-Tech-5.4%, Life Sciences - 5.8%, Travel - 3.4%, Energy - 3.8%, Media-2.3% Others - 4.6%. USD 100mn+ clients: 24.Fixed Price Contracts accounts for 48%. Utilisation (ex.trainees) was at 83.8% & LTM attrition in IT services - 11.3%

Soft performance; Reiterates positive demand outlook for FY16

• In 1QFY16, Revenues grew 3.5% QoQ in constant currency terms led by volume growth (4.8%) & a pricing decrease of 1.3%, led by growth in North America (up 4.4% QoQ), while UK grew 2.8%. In USD terms, revenues at USD 4,036mn (+3.5% QoQ). For FY15, reported revenues were
• INR 256.681bn reflecting a growth of 16.1 % YoY. The shortfall in revenue performance was attributed to softness in Japan, Latin America and Diligenta (which together have cost a revenue loss of around $20 million during the quarter).
• The company reported an 110bps QoQ decline in EBITDA margins in 1Q. Though INR depreciation of ~2.4% aided margins positively by ~70bps, salary hikes had a negative impact of ~190bps. Net profit (one off Employee rewards) was at INR 57.1bn (-3.3% QoQ/12.9% YoY).
• TCS recently launched Ignio, an artificial intelligence-based platform that automates several IT maintenance tasks. IT sector can offer significant benefits in the infrastructure services space where it is estimated that 25% of the tasks performed by production management teams can be eliminated and over 50% of the tasks performed manually today can be automated. TCS management indicated that Ignio has received an encouraging response and it has already won three deals.
• TCS for first time disclosed financial details for company’s ‘Digital Tech’ practices. Digital revenues accounted for 12.5% of companies revenues in Jun’15 quarter (implying ~US$2bn annual revenue run rate) clocking double digit sequential growth. Management indicated increasing traction in digital technology led opportunities. Large chunk of digital revenues is coming from digital transformation projects that fall under application development and maintenance (ADM) work, mobile apps development, big data and analytics, and transformation to hybrid cloud.
• Client metrics and deal wins continued to remain healthy. It added 10, 1 and 1 accounts to the US$20 mn+, US$50 mn+ and US$100 mn+ buckets, respectively. During the Jun’15 quarter, 38 new clients signed for TCS’s cloud platform solution and company is in process of closing 3 deals for its recently launched ‘Ignio’ platform. Company plans to train 1,00,000 employees on digital technologies. TCS won 9 deal wins (BFSI-3, Retail-3, Telecom-1, Manufacturing-1& Media-1) came from across verticals and geographies.
• In 1QFY16, TCS closed the quarter with a headcount of 324,935 employees. It added 20,302 and 5,279 employees on a gross and net basis. Quarterly annualized attrition at 18.6% rose 190 bps qoq and was the highest in the past 20 quarters. Utilization (excluding trainees) was up 90 bps to 86.3% whereas utilization (including trainees) was up 140 bps to 82.9%.  TCS has declared interim dividend of INR 5.5/share post results

Valuation: 

Revenue growth continued to miss estimates for the third consecutive quarter. Although flat growth in 1QFY16, prolonged weakness in Insurance business and impact of sharp cross currency headwinds on EBIT margins remain a concern, the positive management commentary, strong deal pipeline, hiring guidance, uptick in discretionary spends & growth in digital services remain the key positives. 

The stock is currently trading at 20.6x/18.0x FY16/FY17E EPS, which continue to reflect premium valuations compared to peers. We continue to maintain MARKETPERFORMER rating with a target price of 2577 based on target P/E of 18.5x FY17 EPS. Risks: Uncertain global environment can cause demand, pricing pressure. INR appreciation is a risk.

Income Statement
	June 15	March 15	Dec  14	Sep 14	Jun 14	FY 14-15
Revenue	20,073.78	18,798.23	18,936.35	18,405.05	17,438.43	73,578.06
Other Income	893.64	1,299.44	1,503.16	865.17	798.96	4,466.73
Total Income	20,967.42	20,097.67	20,439.51	19,270.22	18,237.39	78,044.79
Expenditure	-13,643.10	-15,300.22	-12,795.13	12,503.67	-11,422.46	-52,021.48
Interest	-1.08	-5.16	-12.54	-58.14	-3.73	-79.57
PBDT	7,323.24	4,792.29	7,631.84	6,708.41	6,811.20	25,943.74
Depreciation	-361.16	-367.29	-350.51	-340.71	-335.26	-1,393.77
PBT	6,962.08	4,425.00	7,281.33	6,637.70	6,475.94	24,549.97
Tax	-1,473.11	-967.74	-1,570.18	-1,376.02	-1,379.07	-5,293.01
Net Profit	5,488.97	3,457.26	5,711.15	4,991.68	5,096.87	19,256.96
EPS	28.02	17.65	29.16	25.48	26.02	98.31