IndiaEquityResearch

ITServices

January02,2012

TataConsultancyServices

ADD
TargetPrice(INR)
Rating

1,304

Robustgrowthdriverspersistbutmarginsmaybepeaking

ThestrengthinBFSIandthehigherexposuretoemergingmarketsare
likelytohelpTCSdeliveraCAGRof18%involumesoverFY12fFY14f.
However, we estimate EBITDA margins to decline by 154bp, given
peakutilizationlevels,INRappreciationandlowSG&Aexpenses,while
leaving few levers for margin improvement. Estimate earnings are
likely to grow at a CAGR of 17% over FY12fFY14f, driven by volume
growth and a modest increase in billing rates led by a shift in the
revenuemixtowardsnonlinearmodels.OurDec12targetofINR1,304
values the stock at 19x oneyear forward earnings. This implies an
upsideof12%.WeresumecoveragewithanAddrating.

LastPrice(INR)

1,161

Bloombergcode

TCSIN

Reuterscode

TCS.BO

Avg.Vol.(3m)(mn)

1.75

Avg.Val.(3m)(INRbn)

1.93

52wkH/L(INR)

1,247/902
15,455

Sensex
MCAP(INRbn/USDbn)

2,272/42.72

Shareholding(%)

6/11

9/11

Promoters

74.1

74.1

MFs,FIs,Banks

8.1

8.1

FIIs

12.8

12.8

Public
Others

4.5
0.5

4.6
0.4

StockChart(RelativetoSensex)
1,250

1,150

BFSIandemergingmarketslikelytodrivegrowth
TCS outperformed peers during the 2009 downturn, both in terms of volume
growth and margin expansion, driven by the BFSI segment, which is TCS
strongholdandcontributes43.5%ofoverallrevenues.BFSIcontinuestoremain
strong, with the company winning sizeable deals in the past two quarters;
however, other verticals such as Manufacturing, Energy and Utilities are also
showingstrongermomentum.WeestimateavolumeCAGRof18%overFY12f
FY14f,drivenbyBFSIandahigherexposuretoemergingmarketscomparedto
peers.WebelieveTCSismostresilienttovolatilityindemand,givenahigher
proportionofrevenuecomingfromclientsnondiscretionaryspend.

MarginboostduetoINRdepreciationunlikelytobesustainable

1,050

950

850
Dec10

Apr11

Aug11

TCS

Dec11

Sensex Rebased

StockPerfm.(%)

1m

6m

1yr

Absolute

4.0

2.0

0.8

Rel.toSensex

8.2

16.0

23.4

03/11

03/12f

03/13f

Financials(INRmn)
Sales

373,245 494,549 588,736

YoY(%)

24 32 19

EBITDA(%)

29.8 30.4 30.2

A.PAT

86,830 107,976 129,997

Sho/s(diluted)

1,957 1,957 1,957

A.EPS(INR)

44.4 55.2 66.4

YoY(%)

26 24 20

D/E(x)

(0.3) (0.4) (0.4)

P/E(x)

26.2 21.0 17.5

EV/E(x)

19.7 14.3 11.8

RoCE(%)
RoE(%)

39 38 36
37 37 36

QuarterlyTrends

12/10

03/11

06/11

09/11

Sales(INRmn)

96,634 101,575 107,970 116,335

PAT(INRmn)

23,566

24,102

24,084

Source:Bloomberg,Company,AvendusResearch

Pleaserefertothedisclaimertowardstheendofthedocument.

24,627

The 400bp expansion in EBITDA margins during FY08FY11 was driven by

operatingleverssuchasutilization,SG&Aexpensesandtheoffshoremix.The
19%depreciationintheINRagainsttheUSDbetweenApr11andDec11islikely
to boost EBITDA margin in FY12 as well, but the lack of sufficient operating
leversmakesthisunsustainable.TCSisoperatingatapeakutilizationof83%,
whereas SG&A expenses are near the historical bottom. While the company
stillhassomemarginleversleft,suchasthefresherexperiencedemployeemix
andanoffshoremix,webelievethattheseareinsufficientforfurthermargin
expansion.WeforecastEBITDAmarginstodeclineby154bpoverFY12FY14.

EPSCAGRof17%overFY12fFY14f,despiteshrinkingEBITDAmargin
We forecast revenues to grow at a CAGR of 21.0% over FY12FY14, led by a
volumeCAGRof18%andamodestincreaseinbillingratesdrivenbyashiftin
therevenuemixtowardsnonlinearmodels.WeestimateanEPSCAGRof17%
overFY12fFY14f,despitea154bpcompressioninEBITDAmarginsandalikely
riseintaxratefrom19.4%inFY11to26%inFY14f,duetostrongvolumeCAGR.

ResumecoveragewithanAddratingandDec12targetofINR1,304
TCS is trading at a oneyear forward P/E of 18.2x, in line with its twoyear
historicaverageP/Eof18.5x.WedonotseeacaseforaP/Ereratingtohigher
levels,giventhatthePEGratiostandsat0.9xcomparedtoitstwoyearhistoric
average of 0.8x. We assume a target P/E of 19x Dec12 EPS and arrive at a
Dec12 target price of INR1,304, which implies an upside of 12%. We resume
coverageonTCSwithanAddrating.AsharpcutinclientsITbudgetsandsharp
fluctuationsintheUSDINRarekeyrisks.
PriyaSunder,+9102266842862
priya.sunder@avendus.com

India Equity Research

TataConsultancyServices

TableofContents

Investmentsummary......................................................................................................................... 3
BFSIandemergingmarketslikelytodrivegrowth................................................................................3
MarginboostduetoINRdepreciationnotsustainable ........................................................................3
EPSCAGRof17%overFY12fFY14f,despiteshrinkingEBITDAmargin.................................................3
ForexlosseslikelytoweighonFY12fearnings......................................................................................3
ResumecoveragewithanAddratingandDec12targetofINR1,304 ...................................................4

BFSIandemergingmarketstodrivegrowth ..................................................................................... 5
Demonstratedresilienceduringdownturn,drivenbyBFSI...................................................................5
SteadydealwinsinBFSI .....................................................................................................................6
however,smallerverticalsalsoshowingmomentum ........................................................................6
Higherexposuretoemerginggeographies ...........................................................................................7
FocusshiftingawayfromtraditionalADM ............................................................................................7
Lowershareofdiscretionaryspending;greaterresilience ...................................................................8

MarginboostduetoINRdepreciationnotsustainable..................................................................... 9
Utilizationlevelsneartheirpeak...........................................................................................................9
SG&Aexpensesnearbottom ................................................................................................................9
Notmuchcomfortinoffshoremixandpricing ...................................................................................10
Employeemixprovidessomeleeway .................................................................................................10
INRdepreciationaddstoEBITDA,butisnotnecessarilyEPSaccretive ..............................................11

EPSCAGRof17%overFY12fFY14f,despiteshrinkingEBITDAmargin........................................... 12
RevenueslikelytogrowataCAGRof21%overFY12fFY14f..............................................................12
EBITDAmarginslikelytocontractby154bpoverFY12fFY14f ..........................................................12
ForexlosseslikelytoweighonFY12fandFY13fearnings...................................................................13
EstimateprofitslikelytogrowataCAGRof17.0%overFY12fFY14f.................................................13

ResumecoveragewithanAddratingandDec12targetofINR1,304 ............................................. 14
Valuationsfair;seelimitedupside ......................................................................................................14
ResumecoveragewithAddrating;upsideof12% ..............................................................................14
Riskfactors ..........................................................................................................................................15

FinancialsandValuations ................................................................................................................ 16

ITServices

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India Equity Research

TataConsultancyServices

Investmentsummary
StrengthinBFSIandhigherexposuretoemergingmarketsarelikelytohelpTCSdeliveravolumeCAGRof18%over
FY12fFY14f.However,weestimateEBITDAmarginstodeclineby154bp,givenpeakutilizationlevelsandlowSG&A
expenses,whileleavingfewleversformarginimprovement.Forexlossesarelikelytoimpactthebottomlinenegatively
inFY12fandFY13f,despiteanupsidetoEBITDAmarginsduetoINRdepreciation.Despitethemargincompression,we
estimateearningstogrowataCAGRof17%overFY12FY14f,drivenbystrongervolumegrowth.WebelievethatTCSis
themostresilienttovolatilityindemand,givenahigherproportionofrevenuecomingfromclientsnondiscretionary
spend,andthusmakingitagooddefensivepick.TCSistradingataoneyearforwardP/Eof18.2x,inlinewithitstwo
yearhistoricaverageP/Eof18.5x.Webelievethecompanyislikelytocontinueitsindustryleadingperformance,but
donotseeacaseforaP/Ereratingtohigherlevels,giventhatthePEGratiostandsat0.9xcomparedtoitstwoyear
historicaverageof0.8x.WearriveataDec12targetpriceofINR1,304basedonourtargetDec12P/Eof19x;thisimplies
an upside of 12%. We resume coverage on TCS with an Add rating. A sharp cut in clients IT budgets and sharp
fluctuationsintheUSDINRratearekeyrisks.

BFSIandemergingmarketslikelytodrivegrowth
SteadydealflowinBFSI
andhigherexposureto
emergingmarketslikelyto
drivegrowth.

TataConsultancyServices(TCS)outperformedpeersduringthe20082009downturn,bothintermsof
volume growth and margin expansion. Volume growth was driven by the Banking and Financial
Services(BFSI)segment,whichisTCSstronghold,contributing43.5%tooverallrevenues,thehighest
amongTierIcompanies.BFSIcontinuestoremainstrong,withTCSwinningsizeabledealsinthepast
twoquarters;whereasotherverticalssuchasManufacturing,EnergyandUtilitiesandLifeSciencesare
alsoshowingstrongmomentum.WebelievethatTCSismostresilienttovolatilityindemand,givena
higher proportion of revenue coming from clients nondiscretionary spend. We forecast a volume
CAGRof18%overFY12FY14drivenbyBFSIandahigherexposuretoemergingmarketscomparedto
peers.

MarginboostduetoINRdepreciationnotsustainable
Insufficientoperating
leverstohelpsustain
marginboostduetoINR
depreciation.

Shiftinrevenuemix
towardsnonlinear
modelstodriveEPSCAGR
of17%overFY12fFY14f,
despiteshrinkingEBITDA
margin.

The 400bp expansion in EBITDA margins during FY08FY11 was driven by taking advantage of
operating levers such as utilization, Selling, General and Administrative (SG&A) expenses and the
offshoremix,therebynarrowingthemargingapversusitsnearestcompetitor.The19%depreciationin
theINRagainsttheUSDbetweenApr11andDec11islikelytoprovideasignificantpunchtoEBITDA
margins in FY12 as well, but lack of sufficient operating levers makes this unsustainable. TCS is
operatingatautilizationof83%,closertoitshistoricmean,whereasSG&Aexpensesasapercentage
ofrevenuesarenearthehistoricalbottom.Whilethecompanystillhassomemarginleversleft,such
asfresherexperiencedemployeemixandanoffshoreeffortmix,webelievethattheseareinsufficient
forfurthermarginexpansion.WeforecastEBITDAmarginstodeclineby154bpoverFY12FY14.

EPSCAGRof17%overFY12fFY14f,despiteshrinkingEBITDAmargin
WeforecastrevenuestogrowataCAGRof21.0%overFY12FY14,ledbyavolumeCAGRof18%anda
modestincreaseinbillingratesdrivenbyashiftintherevenuemixtowardsnonlinearmodels.We
estimateanEPSCAGRof17%overFY12fFY14f,despitea154bpcompressioninEBITDAmarginsanda
likelyriseinthetaxratefrom19.4%inFY11to26%inFY14f,duetoastrongvolumeCAGR.

ForexlosseslikelytoweighonFY12fearnings
Forexlossesdueto
hedginglikelytoimpact
FY12fEPSnegatively.

TCS has USD2,900mn of hedges outstanding currently, the highest in the IT industry, of which
USD2,600mn expires in the Dec11 quarter and the rest in FY13f. For a 1% depreciation in the INR
against the USD, we estimate a net impact of 0.5% on profits. At the prevailing exchange rate of
INR52.0/USD,theimpactcouldbeashighas8.0%;thus,offsettingtheupsidetomarginsinFY12fdue
toINRdepreciation.

ITServices

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India Equity Research

TataConsultancyServices

ResumecoveragewithanAddratingandDec12targetofINR1,304
Resumecoveragewithan
AddratingandDec12TP
ofINR1,304.

TCSistradingataoneyearforwardP/Eof18.2x,inlinewithitstwoyearhistoricaverageP/Eof18.7x.
Webelievethatthecompanyislikelytocontinueitsindustryleadingperformance,butdonotseea
caseforaP/Ereratingtohigherlevels,giventhatthePEGratiostandsat0.9xcomparedtoitstwo
yearhistoricaverageof0.8x.WeassumeatargetP/Eof19xDec12EPS,whichisatthecompanystwo
year historic average. We arrive at a Dec12 target price of INR1,304, implying an upside of 12%. We
resumecoverageonTCSwithanAddrating.AsharpcutinclientsITbudgetsandsharpfluctuationsin
theUSDINRratearekeyrisks.
Exhibit1: OneyearforwardP/E
30
AvgP/E

1yrFwdP/E

TargetP/E

24

18

12

6
Dec06

Nov07

Sep08

Jul09

Jun10

Apr11

Feb12

Dec12

Source:Bloomberg,AvendusResearch

Exhibit2: Valuationsummary
(INRmn)

NetSales

EBITDA

NetProfit

EPS(INR)

P/E(x)

EV/EBITDA(x)

EV/Sales(x)

P/B(x)
8.9

Mar11

373,245

111,118

86,830

44.4

26.2

19.7

5.9

Mar12f

494,549

150,458

107,976

55.2

21.0

14.3

4.3

7.0

Mar13f

588,736

177,704

129,997

66.4

17.5

11.8

3.5

5.6

Mar14f

658,618

185,923

137,830

70.4

16.5

10.8

3.1

4.6

Source:Company,Bloomberg,AvendusResearch

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India Equity Research

TataConsultancyServices

BFSIandemergingmarketstodrivegrowth
TCS outperformed peers during the 20082009 downturn, both in terms of volume growth and margin expansion.
VolumegrowthwasdrivenbytheBFSIsegment,whichisTCSstronghold,contributing43.5%tooverallrevenues,the
highest among TierI companies. BFSI continues to remain strong, with TCS winning sizeable deals in the past two
quarters; however, other verticals such as Manufacturing, Energy and Utilities and Life Sciences are also showing
strongermomentum.WeestimateavolumeCAGRof18%overFY12fFY14f,drivenbyBFSIaswellasahigherexposure
toemergingmarketscomparedtopeers.WebelievethatTCSismostresilienttovolatilityindemand,givenahigher
proportionofrevenuecomingfromclientsnondiscretionaryspend.

Demonstratedresilienceduringdownturn,drivenbyBFSI
RevenueCQGRof4.4%
overSep08Sep11higher
thanthatofpeersINFO
andWPRO.

TCSrevenuesgrewataCQGRof4.4%over Sep08Sep11, whilepeerssuchasInfosys(INFOIN,NR),

andWipro(WPROIN,NR)reportedaCQGRof3.4%and3.1%,respectively.Theoutperformancewas
ledbyBFSI,whichisTCSstronghold,contributing43.5%tooverallrevenues,thehighestamongTierI
ITcompanies.RevenuesfromBFSIgrewataCQGRof4.7%overSep08Sep11.
Exhibit4: RevenueCQGRoverSep08Sep11

Exhibit3: QuarterlyrevenuesofTCS(INRbn)
120

6
3yearCQGR4.4%

95

70

45

0
Sep08

Jun09

Mar10

Dec10

Sep11

Source:Company,AvendusResearch

EBITDAmarginsexpanded
byover400bpbetween
FY08andFY11.

TCS

INFO

WPRO

HCLT

Source:Company,AvendusResearch

The companys EBITDA margins have also expanded by over 400bp between FY08 and FY11 and
currentlystandat29%;thereby,narrowingthemargingapwithINFO.
Exhibit5: EBITDAmargins(%)
TCS

35

INFO

WPRO

HCLT

30

25

20

15
FY09

FY10

FY11

Sep11

Source:Company,AvendusResearch

We believe that the momentum in BFSI is likely to continue, driven by recent deal wins and the
growingtractioninthebankingproductBaNCS.WeestimateavolumeCAGRof18%overFY12fFY1ff.

ITServices

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India Equity Research

TataConsultancyServices

However, we do not see much room for further margin improvement, due to the lack of adequate
levers.Weforeseea154bpcompressioninEBITDAoverFY12FY14.
SteadyincreaseinBFSI
marketshareestablishes
TCSleadershipinthis
vertical.

SteadydealwinsinBFSI
Overthepastfivequarters,TCShassteadilyincreaseditsmarketshareinBFSIascomparedtoother
largerpeers.
Exhibit6: BFSImarketshare(%)
46.5

46.0

45.5

45.0

44.5

44.0
Jun10

Sep10

Dec10

Mar11

Jun11

Sep11

Source:Company,AvendusResearch

Recent deal wins also substantiate the companys leadership in this vertical. Out of 25 large deals
signedinthefirsthalfofthisfiscal,9wereforBankingandInsurance.
Exhibit7: DealwinsinBFSIinthepastthreemonths
Date

Dealdetails

15Sep11 TCSsignedamultiyearcontractwithNets,aleadingpaymentsolutionsproviderinNorway,forApplication
DevelopmentandMaintenance
19Sep11 DeutscheBankselectedTCSasastrategicpartnerforatransformationinitiativeinitscapitalmarketsdivision
20Oct11 CUA,Australiaslargestcustomerownedfinancialinstitution,selectedTCSBaNCSOnlineBankingPlatform
24Oct11 UKbasedScotwestandCapitalCreditUnionsselectedTCS'BaNCScorebankingITplatform
9Nov11 Diligenta,aUKbasedsubsidiaryofTCS,wonaUSD2.2bndealover15yearsfrom'FriendsforLife',alife
insurancefirm
Source:Company,AvendusResearch

Ourdiscussionwithmanagementalsoindicatedcontinuedmomentuminthebusinessenvironment.

however,smallerverticalsalsoshowingmomentum
While BFSI still forms 44%45% of incremental revenues, relatively smaller verticals such as
Manufacturing,Hitech,Retail,LifeSciencesandEnergy&Utilitieshavegainedmomentuminthepast
fourquarters.

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India Equity Research

TataConsultancyServices

Exhibit8: %shareofrevenues

Exhibit9: CQGRoverSep08Sep11

15

9
TCS

10

Industry

0
Manufacturing Retail

Lifesciences Energy&
Utilities

0
BFSI

Source:Company,AvendusResearch

Smallerverticalssuchas
ManufacturingandEnergy
&Utilitiesarealso
showingmomentum.

Manufacturing Retail

Lifesciences

Source:Company,AvendusResearch

Notably, the smaller sectors have grown faster than the rest of the industry. While TCS is likely to
maintainitsleadershipinBFSI,bettergrowth momentumin Manufacturing,andEnergy&Utilitiesis
alsolikelytoaddtovolumegrowth.

Higherexposuretoemerginggeographies
NorthAmericaandEuropetogethercontributec79%torevenues,thelowestamongTierIcompanies.
Exhibit10: Geographymix(%)
69
NorthAmerica

Europe

EmergingMarkets

46

23

0
INFO

TCS

WPRO

HCLT

Source:Company,AvendusResearch

Emerginggeographies
growingfasterthanNorth
AmericaandEurope.

Otheremerginggeographies aregrowingfasterthanNorth AmericaandEurope;thisalsoaidedTCS

outperformanceinthepasttwoyears.
Exhibit11: Growthrateingeographies

NorthAmerica

IberoAmerica

UK

ContinentalEurope India

AsiaPacific

MEA

5.8%

0.8%

4.9%

5.1% 7.5%

10.4%

7.7%

CQGRSep09Sep11
Source:Company,AvendusResearch

FocusshiftingawayfromtraditionalADM
TheshareofApplicationDevelopmentandMaintenance(ADM)intotalrevenueshascomedownby
490bpsinceSep09,whereastheshareofTestingServices,InfrastructureManagement,Consultingand
EnterpriseSolutionshasgoneup.

ITServices

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India Equity Research

TataConsultancyServices

Exhibit12: Proportionofservicelinestototalrevenue

Lowerpenetrationof
outsourcinginEnterprise
SolutionsandConsulting
likelytosupporthigher
growthratesinthese
segments.

Sep09

Sep10

Sep11

ApplicationDevelopmentmaintenance

49.6%

46.8%

44.7%

Sep09Sep11
4.9%

BusinessIntelligence

5.7%

5.6%

4.7%

1.0%

EnterpriseSolutions

0.8%

10.3%

10.3%

11.1%

AssuranceServices(Testing)

4.8%

6.6%

7.6%

2.8%

EngineeringandIndustrialServices

5.0%

4.9%

4.8%

0.2%

InfrastructureServices

8.0%

9.4%

9.6%

1.6%

GlobalConsulting

1.6%

2.1%

2.6%

1.0%

AssetLeverageSolutions(Products)

3.2%

3.4%

4.0%

0.8%

11.8%

10.9%

10.9%

0.9%

BusinessProcessOutsourcing
Source:Company,AvendusResearch

Lower penetration of outsourcing in Enterprise Solutions and Consulting and the increasing
organizational shift towards transformational activities are likely to support higher growth rates in
thesesegments.

Lowershareofdiscretionaryspending;greaterresilience
Lowershareof
discretionaryspending
makesTCSmostresilient
toavolatilebusiness
environment.

With45%ofrevenuescomingfromADM,TCShasthehighestcontributionfromthisservicelineamong
largerpeers.Asmentionedearlier,clientsareincreasinglyshiftingtowardstransformationalworkand
lookingforgreaterengagementswiththeirvendors.Moreover,preferencesareshiftingtowardspre
packaged Enterprise Resource Planning (ERP) software based on emerging trends such as Cloud and
Mobility over traditional custom applications. However, ERP solutions usually form a part of
discretionaryspending,whichareimpactedtoalargerextentduringbudgetcutsinadownturn.
Exhibit13: Segmentalrevenues(%)
50
Consulting+EnterpriseSolutions

ApplicationDevelopment&Maintenance

40

30

20

10

0
TCS

INFO

WPRO

HCLT

Source:Company,AvendusResearch

WebelievethatwhileTCSisbestplacedinaweakdemandenvironment,thecompanyislikelytolose
outtopeersintheeventoffasterimprovementindemand,giventhelowerexposuretoERPSolutions.

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TataConsultancyServices

MarginboostduetoINRdepreciationnotsustainable
The400bpexpansioninEBITDAmarginsduringFY08FY11wasdrivenbytakingadvantageofoperatingleverssuchas
utilization,SG&Aexpensesandtheoffshoremix,therebynarrowingthemargingapversusitsnearestcompetitor.The
19%depreciationintheINRagainsttheUSDbetweenApr11andDec11islikelytoprovideasignificantpunchtoEBITDA
marginsinFY12aswell,butlackofsufficientoperatingleversmakesthisunsustainable.TCSisoperatingatautilization
of83%,closertoitshistoricmean,whereasSG&Aexpensesasapercentageofrevenuesarenearthehistoricalbottom,
at 17.5%. While the company still has some margin levers left, such as fresherexperienced employee mix and an
offshoreeffortmix,webelievethattheseareinsufficientforfurthermarginexpansion.WeforecastEBITDAmarginsto
declineby154bpoverFY12FY14.

Utilizationlevelsneartheirpeak
Utilizationlevelsnear
theirpeak,comparedto
peers.

TCSisoperatingatanoffshoreutilization(extrainees)levelof83.1%,nearthecompanyshistorichigh.
Thisisalsothehighestamongpeers,withINFO,WPROandHCLToperatingat77.3%,80.7%and76.5%,
respectively.
Exhibit14: Offshoreutilization,excludingtrainees(%)
85

83

81

79

77
Sep07

Mar08

Sep08

Mar09

Sep09

Mar10

Sep10

Mar11

Sep11

Source:Company,AvendusResearch

Duringthe20082009downturn,utilizationhadimprovedfrom73.7%inSep08to81.2% inSep10,a
750bp improvement that aided margin expansion of 360bp. Furthermore, management indicated
thatthecompanywouldbecomfortableoperatingatautilizationlevelashighas85%.Whilewethink
thatinthecurrentbusinessenvironmentoperatingatahighutilizationlevelisalright,intheeventofa
suddenandsharpuptickindemandthereisalikelyrisktorevenuegrowthifthecompanydoesnot
maintainanadequatebenchstrength.

SG&Aexpensesnearbottom
SG&Aexpensesasa
percentageofrevenues
areatahistoriclow.

SG&A expenses currently form 17.5% of revenues, nearly at a historic low. The decline in SG&A
expenditure was pronounced during the downturn when it declined by 400bp over Sep08Sep10. It
mightbedifficultforTCStofurtherreduceexpensesfromcurrentlevels,aswebelievethatfocusingon
highgrowth segments such as Consulting and ERP necessitate investments in frontend sales. In
addition, TCS is also making significant investments in emerging technologies such as Social media,
Mobility, Products and Platforms. We estimate TCS to maintain SG&A expenses as a percentage of
revenuesatcurrentlevels.

ITServices

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TataConsultancyServices

Exhibit15: Selling,generalandadminexpensesasapercentageofrevenues
22

20

18

16

14
Sep07

Mar08

Sep08

Mar09

Sep09

Mar10

Sep10

Mar11

Sep11

Source:Company,AvendusResearch

Notmuchcomfortinoffshoremixandpricing
Along with utilization and SG&A expenditure, TCS also exploited a third lever onsiteoffshore
employeemixduringthedownturntosupportmargins.ThiscanbeseenfromExhibit16,whichshows
thatrevenuesfromoffshoreprojectshavegoneupsubstantiallybetweenSep08andSep10.
Exhibit16: OffshoreRevenues(%)
Offshoremixnotan
adequateoperatinglever.

52

49

46

43

40
Sep07

Mar08

Sep08

Mar09

Sep09

Mar10

Sep10

Mar11

Sep11

Source:Company,AvendusResearch

WeforecastthemixtoremainstableasinvestmentsingrowingbusinessessuchasConsultingandthe
shift towards more transformational work, involving greater client engagement, are likely to require
moreresourcesonsite.
Pricing does not provide much comfort either. Since FY08, billing rates for TCS have consistently
declinedeachfiscalandwedonotforeseeanimprovementinpricingassuch,barringthosedrivenby
changingrevenuemodels.

Employeemixprovidessomeleeway
About63%ofTCSemployeeshavemorethanthreeyearsofworkexperience.Intakeofmorefreshers
visvis lateral hires is likely to help the company partly cushion the impact of rising wages and
therebylowerdirectcosts.

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India Equity Research

TataConsultancyServices

Exhibit17: Offshoreemployeeswithmorethanthreeyearsofexperience(%)
Employeemixprovides
someleeway.

65

60

55

50

45
Sep07

Mar08

Sep08

Mar09

Sep09

Mar10

Sep10

Mar11

Sep11

Source:Company,AvendusResearch

Weestimatea50bpexpansioningrossmarginsinFY12fanda40bpdeclineinFY13f,basedonour
employeemixassumptionsandBloombergconsensusonINRmovement.

INRdepreciationaddstoEBITDA,butisnotnecessarilyEPSaccretive
TheINRhasdepreciatedagainsttheUSDbyover19.0%sincethebeginningofFY12fand by8.0%in
thisquartersofar.TheINRhasalsodepreciatedby15.0%againsttheGBPandtheEURsince1Apr11.
Exhibit18: INRmovement(indexed)
USDINR

95

GBPINR

EURINR

105

115

125
Dec10

Mar11

Jun11

Sep11

Dec11

Source:Bloomberg,AvendusResearch

INRdepreciationaddsto
EBITDA,butforexlosses
likelytoimpactprofits
negatively.

Weestimatethata1%depreciationintheINRagainsttheUSDadds47bptoEBITDAmargins.
However, forex losses on currency hedges are likely to impact profits negatively. For every 1%
depreciationintheINRagainsttheUSD,weestimatea60bpnegativeimpactonprofits.

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EPSCAGRof17%overFY12fFY14f,despiteshrinkingEBITDAmargin
We forecast revenues to grow at a CAGR of 21.0% over FY12FY14, driven by a volume CAGR of 18% and a modest
increaseinbillingratesledbyashiftintherevenuemixtowardsnonlinearmodels.WeestimateanEPSCAGRof17%
overFY12fFY14f,despitea154bpcompressioninEBITDAmarginandalikelyriseinthetaxratefrom19.4%inFY11to
26% in FY14f, due to a strong volume CAGR. We also estimate forex losses due to the INR depreciation to weigh on
FY12fearnings.

RevenueslikelytogrowataCAGRof21%overFY12fFY14f
Revenueslikelytogrowat
aCAGRof21%overFY12f
FY14f,drivenbyBFSIand
higherexposureto
emergingmarkets.

WeforecastTCStoregisteraCAGRof18%involumesoverFY12FY14,drivenbyBFSIaswellashigher
exposuretoemergingmarketscomparedtopeers.Whileweestimatetheoverallpricingenvironment
toremainstable,weincorporateamodestriseintheblendedbillingrateforTCS,whichwebelieveis
likely to be driven partly by Cost of Living Allowance (COLA) increases and partly by a shift towards
fixedpricecontractsandoutcomebasedpricingmodels.
Exhibit19: Revenueestimates
(INRmn)
Revenues

FY11

FY12f

FY13f

CAGR

373,245

476,971

558,523

22.3%

Source:Company,AvendusResearch

In the past four years, the proportion of fixedprice projects (FPP) has gone up from 41% in FY07 to
c50%inFY11.
Exhibit20: Revenuesfromfixedpricecontracts(%)
50

47

44

41

38
Sep08 Dec08 Mar09 Jun09 Sep09 Dec09 Mar10 Jun10

Sep10 Dec10 Mar11 Jun11

Sep11

Source:Company,AvendusResearch

EBITDAmarginslikelytocontractby154bpoverFY12fFY14f
While we estimate volumes to grow at a CAGR of 18% over FY12fFY14f, we project a 154bp
compressioninEBITDAmarginsduringthisperiod.Themargincompressionislikelytobedrivenbythe
likelyappreciationintheINRinFY13fandFY14f(accordingtoBloombergconsensus)andhigherSG&A
expenditure, but partially offset by lower cost of sales as the employee mix changes in favor of a
greaternumberoffresherhires.

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Exhibit21: EBITDAestimates
EBITDA(INRmn)

240,000

EBITDAmarginslikelyto
contractby154bpover
FY12fFY14f.

EBITDAMargin%(RHS)

31

180,000

30

120,000

29

60,000

28

27
FY11

FY12f

FY13f

FY14f

Source:Company,AvendusResearch

ForexlosseslikelytoweighonFY12fandFY13fearnings
TCS has USD2,900mn of hedges outstanding currently, the highest in the IT industry, of which
USD2,600mnexpiresintheDec11quarterandtherestinFY13f.
Exhibit22: Outstandinghedges(USDmn)
Hedges

asa%ofFY12frevenues(RHS)

3,000

30

2,000

20

1,000

10

0
TCS

WPRO

HCLT

Source:Company,AvendusResearch

Thehedgesareprimarilyrangeforwardcontractsusingoptionsandtheyaremarkedtomarketatthe
exchangerateprevailingattheendofeachquarter.Fora1%depreciationintheINRagainsttheUSD,
we estimate a net impact of 60bp on profits. At the prevailing exchange rate of INR53.0/USD, the
impactcouldbeashighas8.0%;thus,offsettingtheupsidetomarginsinFY12fandFY13fduetoINR
depreciation.

ProfitslikelytogrowataCAGRof17.0%overFY12fFY14f
Profitslikelytogrowata
CAGRof17%overFf12f
FY14f.

We estimate the tax rate to go up from 19.4% in FY11 to 25% in FY13f due to the expiry of tax
exemptionsundertheSoftwareTechnologyParksofIndia(STPI)Act.
Exhibit23: Profitestimates
(INRmn)
Profits

FY11

FY12f

FY13f

CAGR

87,945

107,542

120,889

17.2%

Source:Company,AvendusResearch

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India Equity Research

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ResumecoveragewithanAddratingandDec12targetofINR1,304
TCSistradingataoneyearforwardP/Eof18.2x,inlinewithitstwoyearhistoricaverageP/Eof18.5x.Webelievethe
companyislikelytocontinueitsindustryleadingperformance,butdonotseeacaseforaP/Ereratingtohigherlevels,
giventhatthePEGratiostandsat0.9xcomparedtoitstwoyearhistoricaverageof0.8x.WeassumeatargetP/Eof19x
Dec12EPS,whichisatthecompanystwoyearhistoricaverage.WearriveataDec12targetpriceofINR1,304,implying
anupsideof12%.ResumecoverageonTCSwithanAddrating.AsharpcutinclientsITbudgetsandsharpfluctuations
intheINRUSDratearekeyrisks.

Valuationsfair;seelimitedupside
P/Einlinewithtwoyear
historicaverage;donot
seeacaseforrerating.

TCSistradingataoneyearforwardP/Eof18.2x,whichisinlinewithitstwoyearhistoricaverageP/E
of 18.5x. We believe the company is likely to continue its industryleading performance, given its
strengthinBFSIandtherecentlargedealwinsand,thus,maintainitsP/Eattheselevels.However,we
donotseeacaseforaP/Ereratingtohigherlevels,giventhatthePEGratiostandsat0.9xcompared
toitstwoyearhistoricaverageof0.8x.
Exhibit24: OneyearforwardP/Egraph
30
1yrFwdP/E

TargetP/E

AvgP/E

24

18

12

6
Dec06

Nov07

Sep08

Jul09

Jun10

Apr11

Feb12

Dec12

Source:Bloomberg,AvendusResearch

ResumecoveragewithAddrating;upsideof12%
Exhibit25: TargetP/Eband
1,800
Price

23x

21x

19x

17x

1,400

1,000

600

200
Dec07

Jun08

Dec08

Jun09

Dec09

Jun10

Dec10

Jun11

Dec11

Jun12

Dec12

Source:Bloomberg,AvendusResearch

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India Equity Research

Resumecoveragewith
AddandDec12TPof
INR1,304;upsideof12%.

WeassumeatargetP/Eof19xDec12EPS,whichisthecompanystwoyearhistoricaverage.Wearrive
at a Dec12 target of INR1,304, implying an upside of 12%. We resume coverage on TCS with an Add
rating.

TataConsultancyServices

Riskfactors
AsharpcutinclientsITbudgetsfor2012.
SharpfluctuationsintheUSDINRrateineitherdirection.
LoweracceptanceofTCSproductsandplatformsolutions.
Lowerlevelofbenchstrengthavailableincaseofasuddenspurtinoutsourcingdemand.

Exhibit26: Valuationsummary
(INRmn)
Mar11

NetSales

EBITDA

NetProfit

EPS(INR)

P/E(x)

EV/EBITDA(x)

EV/Sales(x)

P/B(x)

373,245

111,118

86,830

44.4

26.2

19.7

5.9

8.9

Mar12f

494,549

150,458

107,976

55.2

21.0

14.3

4.3

7.0

Mar13f

588,736

177,704

129,997

66.4

17.5

11.8

3.5

5.6

Mar14f

658,618

185,923

137,830

70.4

16.5

10.8

3.1

4.6

Source:Company,Bloomberg,AvendusResearch

ITServices

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FinancialsandValuations
Incomestatement(INRmn)
Fiscalyearending
Grosssales
Less:Exciseduty
Netsales
Otheroperatingincome
Totaloperatingincome
Totaloperatingexpenses
Netmaterials
Otherdirectcosts
Personnel
SG&A
R&D
EBITDA
Otherincome
Depreciation
EBIT
Interest
RecurringPBT
Netextraordinaryitems
PBT(reported)
Totaltaxes
PAT(reported)
Add:Shareofearningsofassociate
Less:Minorityinterest
Priorperioditems
Netincome(reported)
Avendusnetincome
Dividend+Distributiontax
Sharesoutstanding(mn)
Avendusdilutedshares(mn)
AvendusEPS(INR)

03/10
300,289
0
300,289
0
300,289
214,088
0
8,118
149,143
56,828
0
86,201
2,780
6,610
82,371
536
81,836
0
81,836
12,202
69,634
0
739
0
68,895
68,895

03/11
373,245
0
373,245
0
373,245
262,127
0
11,278
189,241
61,608
0
111,118
6,019
7,214
109,923
774
109,148
0
109,148
21,203
87,945
0
1,116
0
86,830
86,830

03/12f
494,549
0
494,549
0
494,549
344,092
0
12,020
246,895
85,176
0
150,458
1,402
9,752
142,108
469
141,639
0
141,639
32,577
109,062
0
1,086
0
107,976
107,976

03/13f
588,736
0
588,736
0
588,736
411,032
0
13,354
296,280
101,398
0
177,704
9,518
11,731
175,491
477
175,014
0
175,014
43,753
131,260
0
1,264
0
129,997
129,997

03/14f
658,618
0
658,618
0
658,618
472,695
0
15,031
345,699
111,965
0
185,923
15,632
13,123
188,432
365
188,067
0
188,067
48,897
139,170
0
1,340
0
137,830
137,830

45,946

32,103

39,811

47,914

50,801

1,957
1,957
35.2

1,957
1,957
44.4

1,957
1,957
55.2

1,957
1,957
66.4

1,957
1,957
70.4

8.0
20.3
33.1
33.4
33.2
33.2

24.3
28.9
33.4
33.4
26.0
26.0

32.5
35.4
29.3
29.8
24.4
24.4

19.0
18.1
23.5
23.6
20.4
20.4

11.9
4.6
7.4
7.5
6.0
6.0

28.7
27.4
22.7
3.4
14.9

29.8
29.5
22.9
5.5
19.4

30.4
28.7
21.8
1.0
23.0

30.2
29.8
21.7
5.4
25.0

28.2
28.6
20.4
8.3
26.0

Growthratios(%)
Totaloperatingincome
EBITDA
EBIT
RecurringPBT
Avendusnetincome
AvendusEPS

Operatingratios(%)
EBITDAmargin
EBITmargin
Netprofitmargin
Otherincome/PBT
EffectiveTaxrate

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Balancesheet(INRmn)
Fiscalyearending
Equitycapital
Preferencecapital
Reservesandsurplus
Networth
Minorityinterest
Totaldebt
Deferredtaxliability
Totalliabilities
Grossblock
less:Accumulateddepreciation
Netblock
CWIP
Goodwill
Investments
Cash
Inventories
Debtors
Loansandadvances
less:Currentliabilities
less:Provisions
Networkingcapital
Totalassets

03/10
1,957
1,000
207,447
210,404
3,768
7,221
19,260
202,134
56,810
24,541
32,268
9,437
32,415
42,579
46,816
0
58,098
35,338
54,819
0
85,434
202,133

03/11
1,957
1,000
252,087
255,044
3,147
5,425
16,130
247,487
68,941
30,378
38,563
13,403
33,791
23,956
74,353
0
82,016
40,067
58,663
0
137,773
247,487

03/12f
1,957
1,000
320,252
323,209
4,233
5,425
16,130
316,738
83,941
40,130
43,811
13,403
33,791
23,956
115,414
0
108,671
50,639
72,948
0
201,776
316,738

03/13f
1,957
1,000
402,335
405,292
5,497
5,425
16,130
400,084
98,941
51,861
47,080
13,403
33,791
23,956
177,011
0
129,368
58,847
83,372
0
281,853
400,085

03/14f
1,957
1,000
489,364
492,321
6,836
5,425
16,130
488,453
113,941
64,984
48,957
13,403
33,791
23,956
258,813
0
144,723
64,938
100,129
0
368,345
488,453

03/10
68,895
6,610
0
2,729
2,780
75,454
9,566
25,347
0
0
1,770
2,780
30,363
0
176
45,946
21,860
24,263
20,828

03/11
86,830
7,214
0
24,803
6,019
63,222
16,097
18,622
0
0
1,376
6,019
7,168
0
1,796
32,103
7,218
41,117
29,273

03/12f
107,976
9,752
0
22,942
1,402
93,383
15,000
0
0
0
0
1,402
13,598
0
0
39,811
1,086
38,725
41,061

03/13f
129,997
11,731
0
18,480
9,518
113,729
15,000
0
0
0
0
9,518
5,482
0
0
47,914
1,264
46,650
61,597

03/14f
137,830
13,123
0
4,689
15,632
130,631
15,000
0
0
0
0
15,632
632
0
0
50,801
1,340
49,461
81,803

Cashflowstatement(INRmn)
Fiscalyearending
Netprofit
Depreciation
Deferredtax
Workingcapitalchanges
Less:Otherincome
Cashflowfromoperations
Capitalexpenditure
Strategicinvestmentspurchased
Marketableinvestmentspurchased
Changeinotherloansandadvances
Goodwillpaid
Otherincome
Cashflowfrominvesting
Equityraised
Changeinborrowings
Dividendspaid(incl.tax)
Others
Cashflowfromfinancing
Netchangeincash

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KeyRatios
Fiscalyearending
Valuationratios(x)
P/E(onAvendusEPS)
P/E(onbasic,reportedEPS)
P/CEPS
P/BV
Dividendyield(%)
Marketcap./FCF
Marketcap./Sales
EV/Sales
EV/EBITDA
EV/FCF
EV/TotalAssets
NetCash/Marketcap.
Pershareratios(INR)
AvendusEPS
EPS(Basic,reported)
CashEPS
BookValue
Dividendpershare
ROEDecomposition(%)
EBITmargin
Assetturnover(x)
Interestexpenseratio
Taxretentionratio
ROA
Totalassets/equity(x)
ROE
Returnratios(%)
EBIT/CapitalEmployed
ROCE
ROIC
FCF/IC
OCF/Sales
FCF/Sales
Turnoverratios(x)
Grossturnover
Netturnover
Revenue/IC
Inventory/Sales(days)
Receivables(days)
Payables(days)
Workingcapitalcycle(excash)(days)
Solvencyratios(x)
Grossdebttoequity
Netdebttoequity
NetdebttoEBITDA
InterestCoverage(EBIT/Interest)

03/10

03/11

03/12f

03/13f

03/14f

33.0
33.0
30.1
10.8
1.7
30.1
7.6
7.4
25.7
33.6
11.0
2.1

26.2
26.2
24.2
8.9
1.2
35.9
6.1
5.9
19.7
46.5
8.8
3.3

21.0
21.0
19.3
7.0
1.5
24.3
4.6
4.3
14.3
27.4
6.8
5.1

17.5
17.5
16.0
5.6
1.8
20.0
3.9
3.5
11.8
21.2
5.2
7.8

16.5
16.5
15.0
4.6
1.9
17.4
3.4
3.1
10.8
17.4
4.1
11.4

35.2
35.2
38.6
107.5
20.1

44.4
44.4
48.1
130.3
14.1

55.2
55.2
60.2
165.1
17.4

66.4
66.4
72.4
207.1
21.0

70.4
70.4
77.1
251.5
22.2

27.4
1.7
0.3
85.1
38.4
1.0
37.4

29.5
1.7
0.3
80.6
38.6
1.0
37.3

28.7
1.8
0.2
77.0
38.3
1.0
37.3

29.8
1.6
0.1
75.0
36.3
1.0
35.7

28.6
1.5
0.1
74.0
31.0
1.0
30.7

46.0
38.7
51.4
48.8
25.1
21.9

48.9
38.9
57.2
30.8
16.9
12.6

50.4
38.4
62.3
45.1
18.9
15.8

49.0
36.4
65.6
49.7
19.3
16.8

42.4
31.1
64.8
54.3
19.8
17.6

5.3
9.3
2.2
0.0
72.7
134.1
48.6

5.4
9.7
2.4
0.0
68.5
103.3
49.9

5.9
11.3
2.8
0.0
70.4
92.8
55.3

6.0
12.5
3.0
0.0
73.8
92.1
59.3

5.8
13.5
3.1
0.0
75.9
92.8
59.4

0.0
0.3
0.1
153.8

0.0
0.3
0.0
142.0

0.0
0.4
0.0
302.8

0.0
0.4
0.0
367.6

0.0
0.5
0.0
516.1

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subject company/companies and its or their securities. We further certify that no part of our compensation was, is or will be, directly or indirectly related to specific
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Disclaimer
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and/orsellanysecuritiesmentionedhereinand/orofficialconfirmationofanytransaction.Thisdocumentisprovidedforassistanceonlyandisnotintendedtobe,andmustnot
betakenas,thesolebasisforaninvestmentdecision.Theuserassumestheentireriskofanyusemadeofthisinformation.Eachrecipientofthisdocumentshouldmakesuch
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DisclosureofInterestStatement(asofDecember30,2011)

Analystownership
ofthestock

Avendusoritsassociatecompanys
ownershipofthestock

InvestmentBankingmandatewith
associatecompaniesofAvendus

Indiancompanies

HCLTechnologies

Yes

No

No

Infosys

No

No

Yes

TataConsultancyServices

No

No

No

Wipro

No

No

Yes

No
No

No
No

No
No

Internationalcompanies
CreditUnionAtlantic(Australia)
DeutscheBank
FriendsforLife(UK)

No

No

No

Nets(Norway)

No

No

No

ScotwestandCapitalcreditunion(UK)

No

No

No

OUROFFICES
Corporateoffice

InstitutionalBroking

Bangalore

IL&FSFinancialCentre,

IL&FSFinancialCentre,

TheMillenia,TowerA,

BQuadrant,5thFloor,

BQuadrant,6thFloor,

#1&2,10thFloor,MurphyRoad,

BandraKurlaComplex

BandraKurlaComplex

Ulsoor,Bangalore8.India.

Bandra(E),Mumbai400051

Bandra(E),Mumbai400051

T:+918066483600

T:+912266480050

T:+912266480950

F:+918066483636

F:+912266480040

AvendusSecuritiesPrivateLimited SEBIRegistrationNo:

BSECMINB011292639|NSECMINB231294639|NSEF&OINF231294639

ITServices

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