TCS Q1FY08 Result Update (Accumulate)

Robust demand environment; valuation looks expensive

Tata Consultancy Services Ltd’s (TCS) Q1FY08 results were in line with its peer Infosys’ Q1FY08 results, with revenue in line with estimates, but higher than estimated net income on account of higher forex gains and tax write-back. During the quarter, TCS reported 1.1% sequential increase in revenue and net profit to Rs52.03bn and Rs11.85bn respectively. EBITDA margin fell 280bps sequentially in Q1FY08 on account of rupee appreciation and salary hikes.

On account of better than expected Q1FY08 and higher yield on investments, we are increasing our FY08E and FY09E EPS estimates by 6% and 2% to Rs51.7 and Rs60.1 respectively, a two-year EPS CAGR of 19.3%. Our FY08E and FY09E estimates are based on Rs/USD rate of Rs40.5 and Rs40.0 respectively.

TCS, like its peers have underperformed the indices in the last few months on account of sharp rupee appreciation. The company is currently quoting at FY08E and FY09E PER of 21.8x and 18.8x respectively. This is at 10% discount to Infosys’ FY08E and FY09E PER.

Though the demand environment looks robust, we believe that with EPS growth slowing down (19.3% in case of TCS), the company and its larger peers don’t deserve higher valuations. Further, with these companies required to pay full taxes from FY10E onwards, three-year EPS CAGR would be lower. We therefore downgrade TCS from ‘Buy’ to ‘Accumulate’ with a price target of Rs1,130, 5% discount to our targeted Infosys PER. At our target price, TCS would be quoting at 21.8x and 18.8x FY08E and FY09E earnings. However, we would revisit our recommendation if the rupee starts depreciating from the current levels.

TCS Q1FY08 Result Update (Accumulate)