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Kuldeep Koul ([email protected]); +91 22 3982 5521 /Ashish Chopra ([email protected]); +91 22 3982 5424

29 March 2011

Update | Sector: Information Technology

Tata Consultancy Services

Rs1,139 NeutralBSE SENSEX S& P CNX

19,121 5,736

Stock performance (1 year)

Shareholding pattern % (Dec-10)

Y/E March 2011E 2012E 2013E

Sales (Rs b) 373.8 466.3 542.3

EBITDA (Rs b) 111.7 137.7 161.6

NP (Rs b) 85.9 101.3 119.5

EPS (Rs) 43.9 51.8 61.0

EPS Gr. (%) 25.1 18.0 17.9

BV/Sh. (Rs) 127.9 171.0 223.2

P/E (x) 24.2 20.6 17.4

P/BV (x) 8.3 6.2 4.8

EV/EBITDA (x) 18.2 14.4 11.8

EV/Sales (x) 5.4 4.3 3.5

RoE (%) 37.3 34.6 31.0

RoCE (%) 42.7 41.8 37.8

Domestic

Inst, 7.9

Others,

5.3Foreign,

12.8

Promoter74.1

Best in class revenue growth to continuePricing strength to offset impact of wage inflation on margins

We expect TCS to post industry leading revenue growth in 4QFY11 despite seasonal

deceleration in volumes. FY12 may see low single-digit uptick in pricing, but the same is

likely to be more significant in FY13, mainly due to hikes in many EAS contracts that will

come up for renewal (which had seen significant pricing cuts during the downturn). We

believe pricing strength should offset the impact of wage inflation on margins, expected

to stay stable at ~27%. Our estimates are unchanged. Maintain Neutral with a target price

of Rs1,220 (20x FY13E EPS).

Expect TCS to post industry leading volume growth amidst a seasonally weak

4QFY11: The managements commentary around demand visibility, deal pipelines,

discretionary pick-up and potential pricing upticks remains positive. However, 4Q is a

seasonally weak quarter; clients finalize their budgets for the next year during this

quarter, impacting IT spends. We do not expect TCS to materially beat consensus

expectations in 4QFY11, unlike in the recent quarters. However, we expect it to post

industry-leading growth. We are modeling revenue growth of ~5% for 4QFY11, a

deceleration from 3QFY11s 7% but higher than our ~4% growth estimate for Infosys.

Most positive on pricing within our coverage: TCS reiterated that the pricing

environment is more sanguine now than it was last year. The company seems confident

of low single-digit pricing improvement in FY12 and potentially even higher in FY13.While the pricing up-tick may be in low single digits going forward (2-3%), the

management expects the up-tick to be much more significant in FY13. This is primarily

because several contracts, in the EAS segment in particular and elsewhere in general,

saw pricing cuts during the slowdown. These will come up for renewal early next year

and may see pricing being restored to at least the pre-recession levels, which gives

us comfort on the achievability of such expectations.

Remains confident of being able to maintain margins near 27%: The company

maintains its guidance of 27% EBIT margin, and expects pyramid management and

pricing up-tick to ward off pressure from wage inflation. Lateral gross additions (in

India) constituted 41% of gross additions in 9MFY11, v/s 26% in FY10 and 14% inFY09. TCS intends to hire 37,000 employees from campus in FY12, which will facilitate

flattening of the pyramid. We have modeled in a 30bp sequential decline in EBIT

margin in 4QFY11, resulting from a bad debt provision of Rs306m as against a write-

back of Rs331m in the previous quarter, implying a 60bp sequential impact. Rupee

depreciation and employee pyramid management should act as partial offsets.

Estimates unchanged; reiterate Neutral: We expect TCS to maintain industry

leading growth over the next few quarters but believe that such expectations are

already embedded in estimates as well the stock price. TCS trades at 7.5% premium

to Infosys, which in our opinion, is unjustified. We are modeling revenue growth of26% for FY12, higher than our estimate of 22% for Infosys; but remain Neutral on the

stock due to high expectations, higher valuations and TCS being less exposed to

pick-up in discretionary demand. We see better risk-reward in Infosys.

Bloomberg TCS IN

Equity Shares (m) 1,957.2

52-Week Range 1,221/683

1,6,12 Rel. Perf. (%) -5/28/34

M.Cap. (Rs b) 2,229.7

M.Cap. (US$ b) 49.8

350

750

1,150

1,550

Mar-10

Jun-10

Sep-10

Dec-10

Mar-11

TCS Sensex - Rebased

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29 March 2011 2

Status quo on long-term demand outlook; seasonality to drive decelerationin 4QFY11

The management retains its upbeat outlook on demand visibility over the next 12 months.

However, we believe there could be some deceleration in 4QFY11, as this is the quarter

when IT budgets are usually finalized. We do not expect TCS to materially beat our4QFY11 estimates, but expect it to continue posting industry-leading volume and revenue

growth.

Segments such as BFSI and Retail continue to drive growth, while activity remains relatively

slow in Telecom and non-Auto segments within Manufacturing.

We model volume growth of 5% QoQ in 4QFY11 (v/s 5.7% in 3Q, 11.2% in 2Q, and 8.1%

in 1Q). In FY12, we expect volume growth of 23.5% to drive revenue growth of 26.4%.

Revenue growth to decelerate in 4QFY11 on seasonality

The management retains

its upbeat outlook on

demand visibility over the

next 12 months

We believe there could be

some deceleration in

4QFY11, as this is the

quarter when IT budgets are

usually finalized

Source: Company/MOSL

Telecom vertical to continue posting lower than overall revenue growth

The company echoed the consensus outlook on revenue from the Telecom vertical. Though

Telecom revenue should continue to grow, the pace of growth is likely to lag the company

average growth. TCS obtains ~60% of its Telecom revenue from telecom service providers

(TSPs) and the remaining from OEMs. Geographically, ~40% of the Telecom revenue is

from the US, ~40% is from Europe and the remaining is from emerging markets. TCS'Telecom revenue has grown at a CQGR of 4.5% in the past seven quarters (period post

the slowdown), v/s 5.9% CQGR for the company's overall revenue.

Growth momentum in E&U vertical to remain strong

TCS' Energy and Utilities (E&U) vertical posted revenue CQGR of 23.1% over the last

three quarters and 13.6% CQGR over the last seven quarters. Given the small base, even

one large contract tends to bring about a sharp spike in numbers. We expect growth

momentum to remain strong due to the following: [1] small base, [2] large sizes of the

organizations in this space, holding potential for large contracts and [3] increasing

privatization, which is expected to drive the focus on cost efficiency. E&U could make a

double-digit percentage contribution to TCS' revenue in the next few years.

0

500

1,000

1,500

2,000

2,500

1Q

FY09

2Q

FY09

3Q

FY09

4Q

FY09

1Q

FY10

2Q

FY10

3Q

FY10

4Q

FY10

1Q

FY11

2Q

FY11

3Q

FY11

4QF

Y11E

US$mn

-12%

-5%

1%

8%

14%US$ Revenues QoQ Grow th % (RHS)

TCS' Telecom revenue

has grown at a CQGR of

4.5% in the past seven

quarters, v/s its overall

revenue CQGR of 5.9%

E&U could make a

double-digit percentage

contribution to TCS' revenue

in the next few years

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29 March 2011 3

E&U revenue volatile, but growing the fastest on a low base

Several contracts, which saw

pricing cuts during the

slowdown, may see pricing

restored to at least the pre-

recession levels


Single-digit pricing improvement likely in FY12, could be higher in FY13TCS reiterated that the pricing environment is more sanguine now than it was last year.

The company seems confident of low single-digit pricing improvement in FY12 and

potentially even higher in FY13. This would be on the back of 120bp sequential increase in

constant currency pricing in 3QFY11. While the pricing up-tick may be in low single digits

going forward (2-3%), the management expects the up-tick to be much more significant in

FY13. This is primarily because several contracts (particularly in the EAS segment) saw

pricing cuts during the slowdown. These will come up for renewal early next year and

may see pricing being restored to at least the pre-recession levels. Overall pricing would

also be favorably impacted by (a) improvement in revenue mix, driven by pick-up in

discretionary spends, and (b) like-to-like hikes, driven by cost of living adjustments (COLA).

The strength in pricing trend is also ascertained by increases seen across the peer group

in 3QFY11 (with the exception of HCL Tech), and management commentary from various

companies on expectation of further pricing increase in FY12/CY11 (e.g. Cognizant

suggested the possibility of low to mid single digit pricing increase in CY11).

Pricing trends in 3QFY11

Infosys Up 0.5% QoQ in constant currency (Overall)

TCS Up 1.2% QoQ in constant currency (Overall)

Wipro Offshore pricing increased 2.5% sequentially in constant currency, while onsite

pricing declined 0.8%

Cognizant Offshore pricing increased 2% while onsite pricing was up 1.5% sequentially

HCL Tech Flat pricing environment


Pricing and pyramid management to help sustain margins at current levels

TCS' EBIT margin for 3QFY11 was 28.1%. Over the last 10 quarters, EBIT margin has

improved by 600bp, driven by multiple levers. Given its size, this performance is exceptional.

The management maintains its guidance of 27% EBIT margin and expects pyramid

management and pricing up-tick to ward off pressure from wage inflation. Lateral gross

additions (in India) constituted 41% of TCS' total gross additions in 9MFY11, v/s 26% in

FY10 and 14% in FY09. The company intends to hire 37,000 employees from campus in

FY12, which will facilitate flattening of the pyramid. We have modeled in a 30bp sequential

-20%

0%

20%

40%

60%

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

Telecom Energy and Utilities Total

The strength in pricing trend

is also evident in increases

seen across the peer group

in 3QFY11

The management

maintains its guidance

of 27% EBIT margin

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29 March 2011 4

decline in EBIT margin in 4QFY11, resulting from a bad debt provision of Rs306m as

against a write-back of Rs331m in the previous quarter (60bp impact), partially offset by

depreciation of the Rupee (our assumption of Rs45.3). Our EBIT margin assumption for

FY12 stands at 27.5% (v/s 27.8% in FY11).

Aggressive cost management drove margins upwards High lateral additions in 9MFY11 - re-balancing of pyramid a

margin lever, going forward


16%

20%

23%

27%

30%

1QFY08

3QFY08

1QFY09

3QFY09

1QFY10

3QFY10

1QFY11

3QFY11

SGA (% of Revenues) EBIT Margin (%)

-4,000

1,000

6,000

11,000

16,000

21,000

1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

Gross Total Additions Gross Lateral Additions

Underperformance in cash conversion attributed to geographic mix

TCS' working capital management has consistently lagged its primary peer, Infosys,

particularly over the last nine months. On an average, Infosys' OCF/NI has been 134% as

against TCS' 99% since FY09. The differential is more stark, if the last three quarters are

considered. For 9MFY11, the conversion was 82% for TCS and 132% for Infosys. Against

that, capital intensity for both companies has been similar over the past eight quarters -

3.8% for TCS and 3.9% for Infosys.

Cash conversion has trailed Infosys, gap has continuously widened over last three years

On an average, Infosys'

OCF/NI has been 134%

as against TCS' 99%

since FY09


TCS attributes the

differential in conversion

ratio to the higher

proportion of revenue from

India and Latin America

OCF as a % of NI

105 10882

127141 132

FY09 FY10 9MFY11

TCS Infosys

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29 March 2011 5

TCS attributed the differential in this conversion ratio to the increased proportion of revenue

from geographies such as India and Latin America (which has business characteristics

similar to India). Much of the work done in India relates to servicing the government

sector, where the cash cycles tend to be longer. India contributed 9.2% to TCS' revenue

in 3QFY11 v/s just 2.2% for Infosys. Latin America contributed 3.1% of TCS' revenue in3QFY11.

Debtor days have declined for TCS, but remain higher than Infosys

50

60

70

80

90

1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

Infosys TCS


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29 March 2011 6

Financials and Valuation

Income Statement (Rs Million)

Y/E March 2009 2010 2011E 2012E 2013E

Sales 278,129 300,289 373,835 466,252 542,296

Change (%) 21.7 8.0 24.5 24.7 16.3Cost of Services 150,745 157,243 198,325 250,001 291,439

SG&A Expenses 55,606 56,246 63,844 78,524 89,225

EBITDA 71,778 86,800 111,667 137,727 161,632

% of Net Sales 25.8 28.9 29.9 29.5 29.8

Depreciation 5,765 7,291 7,807 9,539 10,044

Other Income -4,673 2,255 3,389 4,789 9,103

PBT 61,340 81,764 107,248 132,977 160,691

Tax 9,362 12,088 20,275 30,585 40,173

Rate (%) 15.3 14.8 18.9 23.0 25.0

Minority Interest 604 1,019 1,085 1,049 1,049

PAT 51,367 68,647 85,888 101,343 119,469

Extraordinary 350 0 0 0 0

Net Income 51,717 68,647 85,888 101,343 119,469

Change (%) 3.0 32.7 25.1 18.0 17.9

Balance Sheet (Rs Million)

Y/E March 2009 2010 2011E 2012E 2013E

Share Capital 979 1,957 1,957 1,957 1,957

Reserves 155,567 207,427 247,463 331,633 433,928

Net Worth 156,545 209,384 249,420 333,590 435,885

Minority Interest 3,098 4,056 4,368 4,368 4,368

Loans 4,505 9,110 8,479 10,400 11,863

Capital Employed 165,149 223,549 263,267 349,358 453,116

Gross Block 57,959 69,461 86,621 89,652 93,778

Less : Depreciation 20,464 27,755 35,562 35,562 35,562

Net Block 37,495 41,706 51,059 54,090 58,217

Other LT Assets 62,353 54,920 59,506 74,001 83,297

Investments 17,257 37,799 20,522 20,522 20,522

C urr. As se ts 109,753 140,120 202,293 285,969 387,839

Debtors 75,276 70,109 94,475 116,145 132,635

Cash & Bank Balance 13,440 10,249 40,342 86,924 160,568

Other Current Assets 21,037 59,762 67,476 82,899 94,636

Current Liab. & Prov 61,709 50,996 70,113 85,224 96,759

Current Liabilities 61,709 50,996 70,113 85,224 96,759

Net Current Assets 48,044 89,124 132,180 200,745 291,080

Misc. Expenses 2 2 2 2 2

Application of Funds165,149 223,549 263,267 349,358 453,116

E: MOSL Estimates

Ratios *

Y/E March 2009 2010 2011E 2012E 2013E

Basic (Rs)

EPS 26.2 35.1 43.9 51.8 61.0Cash EPS 29.2 38.8 47.9 56.7 66.2

Book Value 80.5 107.5 127.9 171.0 223.2

DPS 7.0 20.0 8.5 7.5 7.5

Payout % 26.7 57.0 19.4 14.5 12.3

Valuation (x)

P/E 43.4 32.5 26.0 22.0 18.7

Cash P/E 39.0 29.4 23.8 20.1 17.2

EV/EBITDA 30.7 25.2 19.5 15.5 12.7

EV/Sales 7.9 7.3 5.8 4.6 3.8

Price/Book Value 14.2 10.6 8.9 6.7 5.1

Dividend Yield (%) 0.6 1.8 0.7 0.7 0.7

Profitability Ratios (%)

RoE 36.4 37.3 37.3 34.6 31.0

RoCE 44.2 40.9 42.7 41.8 37.8

Turnover Ratios

Debtors (Days) 94 88 80 82 84

Fixed Asset Turnover (x) 8.2 7.6 8.1 8.9 9.7

* 1:1 bonus in FY07, accordingly ratios are adjusted

Cash Flow Statement (Rs Million)

Y/E March 2009 2010 2011E 2012E 2013E

CF from Operations 57,132 75,938 93,695 110,883 129,513Cash for Working Capital 6,792 -44,271 -12,963 -21,983 -16,691

Net Operating CF 63,925 31,667 80,733 88,899 112,822

Net Purchase of FA -50,234 -4,069 -21 ,746 -27,065 -23,466

Net Purchase of Invest. 9,568 -20,461 17,277 0 0

Net Cash from Invest.-40,666-24,530 -4,469 -27,065 -23,466

Proc. from equity issues -2,164 30,864 -26,075 0 0

Proceeds from LTB/STB -1,978 4,605 -631 1,922 1,462

Net Cash Withdrawn by Tata Sons

Dividend Payments -16 ,029 -45,797 -19,464 -17,174 -17,174

Cash Flow from Fin. -20,171 -10,328 -46,170 -15,252 -15,712

Free Cash Flow 13,691 27,598 58,986 61,834 89,356

Net Cash Flow 3,088 -3,191 30,093 46,582 73,644

Opening Cash Bal. 10,352 13,440 10,249 40,342 86,924

Add: Net Cash 3,088 -3,191 30,093 46,582 73,644

Closing C ash Bal. 13,440 10,249 40,342 86,924 160,568

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N O T E S

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29 March 2011 8

This report is for the personal information of the authorized recipient and does not construe to be any investment, legal or taxation advice to you. Motilal Oswal

Securities Limited (hereinafter referred as MOSt) is not soliciting any action based upon it. This report is not for public distribution and has been furnished to you solelyfor your information and should not be reproduced or redistributed to any other person in any form.

The report is based upon information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied upon such. MOSt or

any of its affiliates or employees shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the

information contained in this report. MOSt or any of its affiliates or employees do not provide, at any time, any express or implied warranty of any kind, regarding

any matter pertaining to this report, including without limitation the implied warranties of merchantability, fitness for a particular purpose, and non-infringement. The

recipients of this report should rely on their own investigations.

MOSt and/or its affiliates and/or employees may have interests/ positions, financial or otherwise in the securities mentioned in this report. To enhance transparency,

MOSt has incorporated a Disclosure of Interest Statement in this document. This should, however, not be treated as endorsement of the views expressed in the report.

Disclosure of Interest Statement Tata Consultancy Services

1. Analyst ownership of the stock No

2. Group/Directors ownership of the stock No

3. Broking relationship with company covered No

4. Investment Banking relationship with company covered No

This information is subject to change without any prior notice. MOSt reserves the right to make modifications and alternations to this statement as may be required

from time to time. Nevertheless, MOSt is committed to providing independent and transparent recommendations to its clients, and would be happy to provide

information in response to specific client queries.

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