IT major TCS is likely to set the tone for earnings this quarter. Cross currency headwinds remain major concern as the company had earlier indicated a 40 basis point impact on margins due to forex moves. Kawaljeet Saluja, ED and head of research, Kotak Institutional Equities speak on what to expect from the TCS earnings this evening.
Below is verbatim transcript of the interview:
Q: Is there scope for disappointment within those numbers in itself? Are you preparing yourself for a worst set of numbers?
A: After a couple of guidance and the briefing during the course of the quarter I will be surprised if there is any disappointment. Whatever disappointment or outlook the management had to lay out was laid out in the first week of March in the sell side briefing. So I guess numbers will be inline with what the management has guided for.
Q: In which case you think the stock is adjusted to those expectations the lower expectations as you put it or do you see scope for disappointment or more selling pressure on the stock tomorrow?
A: I guess the stock will move on the outlook for FY 2016 and this quarter is seasonally weak and pretty much discounted with the stock price.
Q: What are you expecting on the outlook for FY16?
A: The management says that they are going to be inline or better than the NASSCOM guidance I think that should suffice. I don’t think the street is expecting a huge growth premium of TCS over the rest of the competition or over NASSCOM in FY 2016. So, the expectations have adjusted to a slightly lower growth trajectory.
Q: Can you walk us through how the valuation between TCS and Infosys will move from hereon if TCS guides that they will just do better than what the NASSCOM is done and they don’t specifically compare it to their own performance in the previous year. What Infosys might deliver in FY16? How will the valuations between the two companies move?
A: The valuation gap between TCS and Infosys has gone down. The valuation gap is approximately 15 percent nothing more. We don’t see a scenario of conversions of growth between Infosys and TCS in FY 2016. So, the valuation gap remains, TCS has delivered well over the long period of time. Infosys will have to deliver on a consistent basis and catch up on growth before it commands the same multiple as TCS. At least I don’t see that happening in FY 2016.
Q: This time Infosys will come quite late in the day, apart from these two any other company that you think could outperform compared to the kind of estimates that you would have made?
A: Most of the companies have more or less guided down for the quarter. So, there might be a bit of a surprise of 0.5-1 percent here or there. However, the focus would essentially be on FY2016 and not so much on the current quarter.
Q: Where do you expect the big growth triggers to come in from in FY2016? For instance do you now see the digital businesses or the SMAC businesses offer some of these companies pick up more momentum, grow to be of material size?
A: Business of IT companies right now, the way the current demand is structured is essentially divided into two parts. One, the traditional business in which clients are pushing vendors for cost take out and that cost savings is being used to fund the other digital initiatives.
The market for digital is growing and it is up to how well Indian companies can execute to capture that digital opportunity. So, off a low base digital would be a big growth driver in FY2016.
However, more importantly, the broader growth drivers would still in essence see a bit of pickup in financial services, strong deal flows in Europe which is market share gains and US markets which are reasonably healthy. So, traditional drivers along with little bit of digital would be the growth drivers in FY16.
Q: Some of these companies are cash rich, do you think they now need to make big inorganic moves to counter the kind of headwinds that we have seen? Is that something that you would expect may be in next financial year?
A: Question is on utilisation of cash for acquisitions, on that count already companies have started acquiring – Infosys announced the acquisition of Panaya. Tech Mahindra has been quite aggressive. TCS did the major transaction in Japan. So, companies have already started utilising that cash and I think that trend will accelerate.
As far as the cash return is concerned to shareholders, the divided pay-out ratio for Infosys is 40 percent and that has got significant scope to improve which is what investors would be looking forward to when Infosys will announce their capital allocation strategy when the announce the annual results.
Q: TCS stock has been an underperformer when compared to Infosys as well as HCL Tech. If in FY16 they only deliver a growth which is better than the industry growth guidance of 12-14 percent will it be sufficient, how will the stock then perform, will it just be inline with the index, will it be an underperformer still compared to other peers like an Infosys as well as HCL Tech?
A: The relative valuations of TCS versus Infosys now capture relatively lower growth expectation of the street. I think at 15 percent premium the valuations will sustain, I don’t think the street is paying a huge premium to TCS anymore. So, if the deliver inline with NASSCOM then the returns which you will make is pretty much inline with the earnings growth which is like 12-13 percent from the current levels.
Q: How would you rank some of these IT stocks based on your preference or based on your expectation for their performance in the short to medium term?
A: As far as our rating is concerned Infosys and Tech Mahindra are our top picks.
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