TCS - Stretched market expectations - Ambit

With initial signs of a spending recovery in the US market, TCS's consensus earnings estimates for FY15 were upgraded over the past six months. The stock is now trading at premium to its historical multiples. Reverse DCF analysis also indicates that all the positives are already factored in the stock price. Although TCS remains a business with the best execution credentials in the IT services industry, the current valuation of 18.6x FY15 P/E appears expensive. We turn SELLers, valuing TCS at Rs. 2,211, implying 18.7x FY15 P/E.

Competitive position: STRONG Changes to this position: STABLE

Best leveraged to gain from demand recovery

With initial signs of a demand recovery in the US, particularly in the BFSI vertical, TCS is among the best-levered firms to gain from the trend, given that the company has the highest exposure among tier-1 firms to BFSI. Further, TCS is likely to benefit more from recovering discretionary spending, given its relatively lower exposure to on-premise ERP implementation and greater focus on emerging technologies and digital transformation.

Well positioned to gain from outsourcing wave in Europe

As highlighted in our June 2013 note ‘Can Europe save Indian IT', TCS is firmly positioned to gain from the outsourcing trend in the underpenetrated Europe market for at least three reasons: (a) its stronghold on scale services (AM/IMS/Testing/BPO) – given increasing outsourcing in non-discretionary services, (b) better credentials with the UK government, and (c) Alti acquisition providing front-end presence in the French market.

Expect 25% EPS CAGR over FY13-16

With the business structure levered to benefit the most from the current demand trends, we have pencilled in 18.4% USD revenue CAGR over FY13-16. We expect EBITDA margins to decline from 31.6% in 2QFY14 to 29.8% in FY16. Consequently, we expect 25% EPS CAGR over FY13-16. RoE may remain at ~43% by FY16, similar to the FY13 levels.

Current valuations do not justify BUY stance

After the stock price increase of >70% over the last one year, TCS is now trading at a ~10% premium to its historical (five-year average) forward P/E multiple. Indeed, our reverse DCF analysis implies ~14% revenue CAGR over FY13-28 and average EBIT margins of 27% over the same period. We do not see upside to these estimates. We value TCS at Rs. 2,211 (18.7x FY15 P/E) and turn SELLers.

Source : Equity Bulls

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