INSTITUTIONAL EQUITY RESEARCH Page | 1 | PHILLIPCAPITAL INDIA RESEARCH Infosys vs. TCS Premium to accrue over the next few quarters INDIA | IT SERVICES | Sector Update 21 March 2016 Recent outperformance of Infosys in sharp contrast to the sector Over the last few months, Infosys’ stock has significantly outperformed TCS’ (3m – TCS 1%, Infosys +12%). Even over 6/12 months, Infosys has outperformed (6m Infosys +9% vs. TCS ‐7%; 12m Infosys +4%, TCS ‐13%) – as the company continues to deliver ahead of expectations, in a weak macro environment for Indian IT services. History points at Infosys gaining a premium vs. TCS soon: We see a build‐up over two years Our analysis of the one‐year‐forward P/E multiples of TCS and Infosys over the last eleven years (since TCS’ listing) reveals that Infosys starts trading at a premium to TCS as soon as its growth rate is about to come at par with TCS. However, TCS needs to report consistently superior growth to trade at a premium to Infosys. Over the last eleven years, TCS has traded at a premium to Infosys in two prolonged periods (October 2007 to April 2008 and April 2011 to December 2015) – when the company had delivered much superior results to Infosys. We attribute the historical premium that Infosys has enjoyed over TCS to the former’s superior margins pre‐2010. Over 2009‐2014, as its margins fell by 640bps, TCS’ expanded by 490bps – this, along with the latter’s superior growth rate, led to TCS gaining a significant premium over Infosys. We see Infosys reclaiming its industry‐leading growth position over the next two years and expanding margins – therefore, we see TCS’ valuation premium turning into a discount. Also, we note that the maximum premium/discount that either company has enjoyed over the other has remained ~20% ‐ with a peak at 40%. Overall, the premium that Infosys has had over TCS, in the +/‐ 1σ range, has been 3.4. Infosys: All set to regain the bellwether tag Infosys’s 3QFY16 guidance‐upgrade implies that the company will report superior growth to TCS in FY16, even if achieves only the lower end of its guidance. The management expects to report industry‐leading growth in FY17 (their internal target is 16% USD revenue growth in FY17), but we expect this to happen by FY18. With its aspirations to reach US$ 20bn in revenues (with US$ 1.5bn from acquisitions and 10% from new services) with EBIT margins of 30% by 2020, we believe the company is all set to regain its bellwether tag. Over the last seven quarters, Infosys has shown a remarkable turnaround in its operating metrics – the number of its +US$ 200/100/50/30mn clients have increased to 6/14/50/85 from 3/13/42/70. With TCV of US$ 2bn in 9MFY16, it has already surpassed its total deal wins in FY15 (US$ 1.95bn). We expect the strong growth momentum based on these improving operating metrics to continue. TCS: Signs of the engine slowing down 3QFY16 was the sixth consecutive quarter in which TCS missed expectations, which we see as signs of the large base and high expectations catching up. For TCS to grow in double digits on its current base, it needs to add US$ 1.6bn revenues annually – a herculean task for any company. Given the persistent weakness in its telecom, insurance, and E&U verticals (25% of revenues), we expect TCS to fail to achieve double‐digit growth in FY17 and beyond. Also, TCS appears to be quite reluctant to adopt the inorganic route to acquire delivery capabilities in the digital space (read our detailed report here , in which we highlighted this as the main rationale for downgrading the sector). While all its competitors – Infosys, Wipro, TechM, and Mindtree – have been acquiring niche companies in the digital space, TCS continues to focus on its in‐house capabilities – which we believe will be difficult to market due to the global ‘perception’ of Indian IT companies. Upgrading multiple for Infosys – parity turns into premium We upgrade our valuation multiple for Infosys to 20x (from 18x earlier) and TP to Rs 1420 from Rs 1280. For TCS, we maintain our valuation multiple at 18x and TP at Rs 2525. We expect the 10% premium (which we have assigned to Infosys) to gradually expand over the next few quarters. We maintain Buy on Infosys and Neutral on TCS. Companies Infosys CMP 1195 Rating BUY TP 1420 Upside 19% TCS CMP 2425 Rating NEUTRAL TP 2525 Upside 4% KEY FINANCIALS INFOSYS Rs Bn FY16E FY17E FY18E Net Sales 617.8 685.1 767.3 EBIDTA 170.1 191.6 217.2 Net Profit 135.5 152.5 171.7 EPS, Rs 59.3 66.7 75.1 PER, x 20.2 17.9 15.9 EV/EBIDTA, x 14.1 12.3 10.6 P/BV, x 4.8 4.3 3.8 ROE, % 23.9 23.9 23.7 Source: PhillipCapital India Research Est. TCS Rs bn FY16E FY17E FY18E Net Sales 1,078.9 1,180.0 1,282.3 EBIDTA 305.6 321.8 347.6 Net Profit 242.3 262.2 288.4 EPS, Rs 123.4 133.5 146.8 PER, x 19.7 18.2 16.5 EV/EBIDTA, x 15.4 14.5 13.4 P/BV, x 7.0 5.8 4.9 ROE, % 35.6 31.9 29.6 Source: PhillipCapital India Research Est. Vibhor Singhal (+ 9122 6667 9949) [email protected]
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INSTITUTIONAL EQUITY RESEARCH
Page | 1 | PHILLIPCAPITAL INDIA RESEARCH
Infosys vs. TCS
Premium to accrue over the next few quarters
INDIA | IT SERVICES | Sector Update
21 March 2016
Recent outperformance of Infosys in sharp contrast to the sector Over the last few months, Infosys’ stock has significantly outperformed TCS’ (3m – TCS 1%, Infosys +12%). Even over 6/12 months, Infosys has outperformed (6m Infosys +9% vs. TCS ‐7%; 12m Infosys +4%, TCS ‐13%) – as the company continues to deliver ahead of expectations, in a weak macro environment for Indian IT services.
History points at Infosys gaining a premium vs. TCS soon: We see a build‐up over two years Our analysis of the one‐year‐forward P/E multiples of TCS and Infosys over the last eleven years (since TCS’ listing) reveals that Infosys starts trading at a premium to TCS as soon as its growth rate is about to come at par with TCS. However, TCS needs to report consistently superior growth to trade at a premium to Infosys. Over the last eleven years, TCS has traded at a premium to Infosys in two prolonged periods (October 2007 to April 2008 and April 2011 to December 2015) – when the company had delivered much superior results to Infosys.
We attribute the historical premium that Infosys has enjoyed over TCS to the former’s superior margins pre‐2010. Over 2009‐2014, as its margins fell by 640bps, TCS’ expanded by 490bps – this, along with the latter’s superior growth rate, led to TCS gaining a significant premium over Infosys. We see Infosys reclaiming its industry‐leading growth position over the next two years and expanding margins – therefore, we see TCS’ valuation premium turning into a discount.
Also, we note that the maximum premium/discount that either company has enjoyed over the other has remained ~20% ‐ with a peak at 40%. Overall, the premium that Infosys has had over TCS, in the +/‐ 1σ range, has been 3.4.
Infosys: All set to regain the bellwether tag Infosys’s 3QFY16 guidance‐upgrade implies that the company will report superior growth to TCS in FY16, even if achieves only the lower end of its guidance. The management expects to report industry‐leading growth in FY17 (their internal target is 16% USD revenue growth in FY17), but we expect this to happen by FY18. With its aspirations to reach US$ 20bn in revenues (with US$ 1.5bn from acquisitions and 10% from new services) with EBIT margins of 30% by 2020, we believe the company is all set to regain its bellwether tag.
Over the last seven quarters, Infosys has shown a remarkable turnaround in its operating metrics – the number of its +US$ 200/100/50/30mn clients have increased to 6/14/50/85 from 3/13/42/70. With TCV of US$ 2bn in 9MFY16, it has already surpassed its total deal wins in FY15 (US$ 1.95bn). We expect the strong growth momentum based on these improving operating metrics to continue.
TCS: Signs of the engine slowing down 3QFY16 was the sixth consecutive quarter in which TCS missed expectations, which we see as signs of the large base and high expectations catching up. For TCS to grow in double digits on its current base, it needs to add US$ 1.6bn revenues annually – a herculean task for any company. Given the persistent weakness in its telecom, insurance, and E&U verticals (25% of revenues), we expect TCS to fail to achieve double‐digit growth in FY17 and beyond.
Also, TCS appears to be quite reluctant to adopt the inorganic route to acquire delivery capabilities in the digital space (read our detailed report here, in which we highlighted this as the main rationale for downgrading the sector). While all its competitors – Infosys, Wipro, TechM, and Mindtree – have been acquiring niche companies in the digital space, TCS continues to focus on its in‐house capabilities – which we believe will be difficult to market due to the global ‘perception’ of Indian IT companies.
Upgrading multiple for Infosys – parity turns into premium We upgrade our valuation multiple for Infosys to 20x (from 18x earlier) and TP to Rs 1420 from Rs 1280. For TCS, we maintain our valuation multiple at 18x and TP at Rs 2525. We expect the 10% premium (which we have assigned to Infosys) to gradually expand over the next few quarters. We maintain Buy on Infosys and Neutral on TCS.
History points to Infosys trading at a premium soon Our analysis of the one year forward P/E multiple of TCS and Infosys over the last eleven years reveals that Infosys starts trading at a premium to TCS as soon as its growth rate is about to come at par with TCS – while TCS needs to report consistently superior growth to trade at premium to Infosys. Over the last eleven years, TCS has traded at a premium to Infosys in two prolonged periods (Oct‐07 to Apr‐08 and April‐11 to Dec‐15) – during which the company was delivering much superior results to Infosys. One‐year‐forward P/E multiple trend for Infosys and TCS
Infosys’s premium over TCS has had a strong correlation with revenue growth rates
Source: Company, Phillip Capital India Research
5
10
15
20
25
30
Apr/05
Oct/05
Apr/06
Oct/06
Apr/07
Oct/07
Apr/08
Oct/08
Apr/09
Oct/09
Apr/10
Oct/10
Apr/11
Oct/11
Apr/12
Oct/12
Apr/13
Oct/13
Apr/14
Oct/14
Apr/15
Oct/15
Infosys TCS
‐10
‐8
‐6
‐4
‐2
0
2
4
6
8
Apr/05 Apr/07 Apr/09 Apr/11 Apr/13 Apr/15
+1σ
‐1σ
‐10
‐8
‐6
‐4
‐2
0
2
4
6
8
Apr/05 Apr/07 Apr/09 Apr/11 Apr/13 Apr/15
+1σ
‐1σ
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
Apr/05 Apr/07 Apr/09 Apr/11 Apr/13 Apr/15
Infy Rev Gr TCS Rev Gr
0%
10%
20%
30%
40%
50%
60%
Apr/05 Apr/07 Apr/09 Apr/11 Apr/13 Apr/15
Infy PAT Gr TCS PAT Gr
P/E Infosys TCS Premium
Mean 18.6 18.3 0.2
Median 17.8 19.1 0.3
Std Dev 4.2 4.0 3.4
High 30.5 26.9 6.5
Low 10.4 6.9 ‐9.1
IT SERVICES SECTOR UPDATE
Page | 3 | PHILLIPCAPITAL INDIA RESEARCH
The historical premium that Infosys has enjoyed over TCS can be attributed to the superior margins that Infosys used to report pre‐2010. Over 2009‐2014, as the margins for Infosys fell by 640bps, TCS expanded its margins by 490bps. This, along with much superior growth rate, led to TCS trading at a significant premium to Infosys. Over the next two years, as we see Infosys reclaiming its industry leading growth position and expand margins, we see TCS’ valuation premium changing into a discount.
Infosys set to reverse the revenue growth and margin trends over the next two years
Source: Company, Phillip Capital India Research
Also, we note that the maximum premium/discount that either of the two companies has enjoyed over each other has remained in the range of ~20% ‐ with a peak of 40%. Overall, the premium enjoyed by Infosys over TCS, in the +/‐ 1σ range, has been 3.4. We expect Infosys’ premium over TCS to build up gradually over the next two years. Valuation gap reversing, as the growth and margin trends are expected to reverse
Recent outperformance of Infosys in sharp contrast to the sector Over the last few months, Infosys’ stock has significantly outperformed TCS’ (3m – TCS +1%, Infosys +12%). Even over 6/12 months, Infosys has outperformed (6m Infosys +9% vs. TCS ‐7%; 12m Infosys +4%, TCS ‐13%) – as the company continues to surprise positively in a weak macro environment for Indian IT services. Quarterly USD revenue growth of Top‐5 Indian IT companies % qoq growth Sep‐14 Dec‐14 Mar‐15 Jun‐15 Sep‐15 Dec‐15TCS 6.4 0.1 (0.8) 3.5 3.0 (0.3)Infosys 3.2 0.8 (2.7) 4.5 6.0 0.6Wipro* 1.8 1.3 (1.2) 1.1 2.1 0.3HCL Tech 1.9 4.0 (0.0) 3.2 0.4 1.4Tech Mahindra 5.2 2.7 6.5 0.5 2.2 0.4
Source: Companies, PhillipCapital India Research Infosys: All set to regain the bellwether tag Infosys’s 3QFY16 guidance upgrade implies that the company will report superior growth to TCS in FY16, even if it achieves the lower end of its guidance. The management expects it to report industry leading growth in FY17 (their internal target of 16% USD revenue growth in FY17) – we expect this to happen by FY18. With its aspirations to reach US$ 20bn in revenues (with US$ 1.5bn from acquisitions and 10% from new services) with EBIT margins of 30% by 2020, we believe the company is all set to regain its bellwether tag. Annual USD revenue growth for the top‐5 Companies FY15 FY16E FY17E FY18ETCS 15.0 7.4 9.4 8.7 Infosys 5.6 9.0 11.0 12.0 Wipro* 7.0 3.7 10.4 6.6 HCL Tech 11.1 8.4 11.5 10.3 Tech Mahindra 18.3 10.5 8.6 9.1
Source: Companies, PhillipCapital India Research Over the last seven quarters, the company has shown remarkable turnaround in operating metrics – the number of its +US$ 200/100/50/30mn clients have increased to 6/14/50/85 from 3/13/42/70. With TCV of US$ 2bn in 9MFY16, it has already surpassed its total deal wins in FY15 (US$ 1.95bn). We expect the strong growth momentum, on these improving operating metrics, to continue. Infosys: Significant improvement in client metrics Infosys: Deal‐flow has been impressive in FY16
0
20406080
100120140160180200
1QFY14
2QFY14
3QFY14
4QFY14
1QFY15
2QFY15
3QFY15
4QFY15
1QFY16
2QFY16
3QFY16
$ 25mn $50mn $75mn
$ 100mn $ 200mn $ 300mn
600
450500
700 700600
213
440
688
983
360
0
200
400
600
800
1,000
1,200
1QFY14
2QFY14
3QFY14
4QFY14
1QFY15
2QFY15
3QFY15
4QFY15
1QFY16
2QFY16
3QFY16
dealflo
w (U
S$ m
n)
Source: Company, Phillip Capital India Research
Page | 4 | PHILLIPCAPITAL INDIA RESEARCH
IT SERVICES SECTOR UPDATE
TCS: Signs of the engine slowing down 3QFY16 was the sixth consecutive quarter in which TCS missed expectations. We see these as signs of the large base and high expectations catching up. For TCS to grow in double digits on its current base, it needs to add US$ 1.6bn revenues annually – a herculean task for any company. Given the persistent weakness in telecom, insurance and E&U verticals (25% of revenues), we expect TCS to fail to achieve double‐digit growth rate in FY17 and beyond. TCS has reported below‐expected revenue growth for the last seven quarters
Quarter Expected
Rev Growth Reported
Revenue growth Miss vs.
consensusSegment attributable to weakness
2QFY15 7.0% 6.4% 64bps Diligenta, Telecom, Latin America 3QFY15 0.8% 0.1% 75bps Diligenta 4QFY15 0.8% ‐0.8% 159bps Diligenta, Telecom, E&U 1QFY16 4.2% 3.5% 71bps Diligenta, Latin America, Japan 2QFY16 4.0% 3.0% 103bps Diligenta, Latin America, Japan 3QFY16 0.9% ‐0.3% 116bps Diligenta, Japan, India
Source: Company, Phillip Capital India Research Incremental revenue for TCS – to peak out in FY15
Source: Company, Phillip Capital India Research Also, TCS appears to be quite reluctant to choose the inorganic route to acquire delivery capabilities in the digital space. While all its competitors (Infosys, Wipro, TechM, Mindtree) have been acquiring niche companies in the digital space, TCS continues to focus on its in‐house capabilities – which, we believe, will be difficult to market due to the ‘perception’ of the Indian IT companies. Read our detailed report here, in which we highlighted this as the main rationale for downgrading the sector. Recent acquisitions by Indian companies Company Acquisitions in Traditional Space Acquisitions in Digital Space Infosys Lodestone Skava, Panaya, Noah ConsultingTCS Alti, Neotel ‐ Wipro Cellent, VITEOS, Healthplan DesignitHCL Tech Axon ‐ Mindtree Aztecsoft Discoverture, Bluefin, Relational TechM Satyam, Comviva, BASF, LCC Sofgen
Rating Methodology We rate stock on absolute return basis. Our target price for the stocks has an investment horizon of one year. Rating Criteria Definition
BUY >= +15% Target price is equal to or more than 15% of current market price
NEUTRAL ‐15% > to < +15% Target price is less than +15% but more than ‐15%
SELL <= ‐15% Target price is less than or equal to ‐15%.
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Page | 12 | PHILLIPCAPITAL INDIA RESEARCH
IT SERVICES SECTOR UPDATE
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