The June quarter numbers of top-tier software services companies indicate that the recovery in the IT sector is picking up at a modest pace. But the shining exception to the trend is TCS. Its financials have reinforced the justification for premium valuation multiples that are accorded to the company, when compared to other large IT firms.
Across parameters such as revenue growth, operating margin, and metrics such as utilisation and attrition, TCS has scored over Infosys, Wipro and HCL Technologies (HCL).
Infosys and HCL delivered reasonable numbers, while Wipro continues to record tepid revenue growth figures. Large-sized customer additions were healthy for TCS, Infosys and HCL.
Delivering outperformance
TCS’ revenues grew by 1.6 per cent (4.1 per cent in constant currency) sequentially (QoQ) in dollar terms. Infosys’ revenues increased by 0.9 per cent (2.1 per cent) and HCL’s by 0.8 per cent (2.7 per cent). In contrast, Wipro’s revenues declined by 1.7 per cent (up 0.1 per cent in constant currency) sequentially. Constant currency figures here represent the growth had the dollar value remained unchanged against the rupee in the June quarter. In other words, they show the revenue growth numbers without taking into account the currency fluctuation impact and are used by analysts to gauge the financials.
Incidentally, HCL recorded revenues of $2,055 million during the quarter, while Wipro delivered $2,027 million. If the trend sustains through FY19, HCL will be the third largest India-listed IT services company, displacing Wipro from the position.
In terms of operating margin, TCS (25 per cent) led the front, followed by Infosys (23.7 per cent), HCL (19.7 per cent) and Wipro (17.2 per cent).
Scoring on key metrics
The banking, financial services and insurance (BFSI) vertical is among the largest segment for these software majors and generates 24-32 per cent of their revenues.
Here, too, TCS scored over others as its BFSI segment grew at a healthy 3.7 per cent. Wipro recorded a 3 per cent growth in the vertical, while Infosys and HCL witnessed a decline in revenues.
Infosys led the way in terms of large-sized client additions. It was able to add four new customers in the $100 million category. TCS added two customers, while HCL got one client in this category. Wipro did not have any additions. Client traction appears to be fairly robust for three of the top four players.
Another metric used to measure efficiency is utilisation, which indicates the proportion of the workforce of these IT companies that is billed to clients. It indicates the level to which vendors have engaged with clients. Infosys recorded a utilisation rate of 85.7 per cent, and Wipro (85.2 per cent) and HCL (85.5 per cent) were at similar levels.
IT companies have been increasing their utilisation rates steadily over the past couple of years. By doing so, they have reduced the bench strength — the part of the workforce that is unbilled or is undergoing training. In other words, these companies are more focused on ready-to-be-billed candidates.
Employee attrition was well in control for TCS, at just 10.9 per cent. HCL (16.3 per cent) and Wipro (17.7 per cent) experienced higher attrition rates. But Infosys recorded the highest attrition among peers, with an employee turnover of 23 per cent in the June quarter. What is worse for the company is that it is losing senior management personnel in quick intervals, with CFO MD Ranganath being the latest exit. The June quarter usually sees high attrition levels in IT companies as many employees quit their software jobs and go for higher studies — pursuing MBA and MS in India or abroad. Since admissions to colleges happen in the April-June period, software companies witness a spike in employee turnover during the quarter. Even so, Infosys’ attrition numbers are quite high and may be a cause for concern.
Premium valuations
TCS trades at 28 times its trailing 12 months per share earnings. Infosys trades at a price earnings multiple of 19 times, while HCL (15 times) and Wipro (16 times) lag behind. Trade body Nasscom expects the IT industry’s revenues to grow by 7-9 per cent in FY19. TCS looks set to record double-digit revenue growth and exceed the industry’s rate.
The markets, thus, have accorded rich valuations — perhaps justifiably so — to TCS vis-à-vis peers. Competitors may need to do a lot more on the revenue and margin front to come close to TCS’ PE multiples.