Tata Consultancy Services Ltd
TCS is India’s first and largest software exporter. The company’s long-term success comes from a disciplined approach to project execution and a concerted emphasis on customer satisfaction.
TCS’ extensive global delivery network and full suite of IT services allows the firm to support the world’s largest enterprises, which sets it apart from smaller rivals. The firm’s operations are fairly concentrated in North America, application development and maintenance, as well as banking, financial services, and insurance (BFSI).
TCS is looking to diversify its exposure. We expect the firm to grow its presence in underpenetrated geographies while developing its expertise in industries outside BFSI and in services associated with social, mobile, analytics, and cloud-based (SMAC) technologies.
To achieve this, organic growth will be supplemented with acquisitions.
Fair Value Estimate: Rs 2,540
Our fair value estimate implies forward fiscal-year price/earnings of 23 times, an enterprise value/EBITDA of 17 times, and a free cash flow yield of 3.5%.
Barring any momentous acquisitions, we think the firm’s top-line growth rate will be less prolific than its historical average due to the increasing maturity of the North American and European outsourcing markets (excluding Continental Europe).
In addition, we believe the law of larger numbers and tougher comparable growth rates will dampen TCS’ forward growth rate. We forecast mid- to high-teens revenue growth for the company over our explicit forecast period, which is still impressive for such a large company.
TCS has a targeted operating margin band of roughly 26%-28%. We assume the firm will be able to manage this margin level going forward and believe the company will be able to offset slightly higher employee costs by reducing its SG&A expenses.
Our DCF model assumes that TCS will generate a return on invested capital that comfortably covers the firm’s 10% weighted average cost of capital.
Economic Moat: Narrow
TCS has a narrow economic moat given meaningful switching costs. The company is focused on establishing and fostering deep customer relationships that provide the firm with long-dated and consistent business. Once established within a client, TCS’ end-to-end services portfolio and ubiquitous global presence allow the firm to cross-sell and develop deeper roots with clients.
At the end of fiscal year 2014, TCS had grown its $1 million-plus client base to over 1,500, from roughly 360 in 2005, which demonstrates TCS’ ability to attract and expand within large clients. In addition, we estimate group revenue from repeat business to be in the high-90s. This high rate of repeat business exemplifies clients’ reluctance to switch between IT service vendors as established end-to-end vendors become more intertwined in the central IT operations of its customers.
Still, we are reluctant to assign TCS a wide economic moat given the firm’s use of an industrial model that leverages a largely junior workforce that often relies on scale to be competitive. In addition, TCS lacks a strong consulting practice and faces competitive threats in service areas such as business process outsourcing (BPO) and application development and maintenance.
Risk
- TCS’ primary risk is the highly competitive IT services industry. The firm needs to continually reinvest in new intellectual property and deliver differentiated services, or face commoditization and competitive displacement.
- Potentially restrictive immigration reform could reduce TCS’ ability to use offshore leverage for onshore work, which would increase staff costs.
- With TCS generating the majority of its revenue from offshore markets, fluctuations in the rupee can have a noticeable impact on financial results, too.
- Macroeconomic weakness in the North American market (roughly 55% of group revenue) or the BFSI industry (approximately 43% of group revenue) will have a substantial impact on the company’s overall results.
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