Tata Consultancy Services Limited - Strong earnings trajectory to continue - Antique

Our Buy rating is led by our view that 1) Company will benefit from strong recovery in BFSI space and uptick in demand from US and European markets; 2) Unlike peers, growth for the company has been broadbased with strong growth across all key verticals; 3) It has been able to improve penetration across most key client buckets, which should help grow despite its high scale; and 4) We see upside risk to street estimates for FY15e.

BFSI: See strong uptick

Our recent checks with IT service vendors indicate a likely strong traction in BFSI. Renewed focus by banks to reduce costs, investments in risk and compliance, infrastructure modernisation, and investments in customer experience and security is driving spends. Our checks indicate healthy pipeline for 4Q. If closed, these should lead to strong growth in FY15e. BFSI segment is estimated to grow 13% during FY14e for Tier I firms, with growth rates likely to improve to 17% during FY15e. BFSI contributes ~36% towards the sector and along with manufacturing, remains a key growth driver. TCS has the highest exposure to BFSI with 43% and should gain from a recovery in this space.

Broadbased growth, trends similar to FY11

Unlike peers, growth has been broadbased, with most key verticals showing growth. Trends during 1HFY14 were similar to FY11, when growth rates improved for the sector.The company has been able to improve market share in key segments such as BFSI and manufacturing, which is aiding revenue growth. TCS has highest exposure to BFSI and should benefit from improving spend in the sector.

Improving client penetration levels

Ability to manage growth and scale remains a key concern for investors. The company has consistently improved penetration levels within its clients. Almost all key client buckets have doubled over last four-to-five years. Client penetration metrics is quite superior to its IT peers. Ability to cross-sell new service lines and improved penetration levels helped deliver growth despite its large scale.

See upside to consensus earnings

We see scope for consensus earnings upgrade in TCS post the 3Q/4Q results. Based on historical trends, TCS has reported full-year earnings at least 9-33% ahead of 4Q exit run rates. Street estimates currently imply only a 3% growth over 4QFY14 earnings, which is quite low in our view. See scope for at least 10% earnings upgrade for FY15e.

Valuations and outlook

Despite the stock outperforming broader markets by 30%, we retain our Buy rating, given likely strong earning CAGR of 24% over FY13-16e. While we have assumed EBIT margins of ~29% for FY14e and FY15e, even assuming margins to be at ~28% in line with the company's stated target, earnings are likely to grow at 22% CAGR over FY13-16e. Downside in the stock price is limited in our view. We retain our Buy rating with target price of INR2,500 per share.

Source : Equity Bulls

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