Five reasons behind TCS downgrade
Slowdown in sector, lack of consolidation may result in lower pricing pressure and impact profitability
BS Reporter / Mumbai Jul 13, 2012, 14:56 IST
After a dismal performance by Infosys and a crash in its share price, TCS results provided much needed relief. Reacting to its results, TCS' stock moved up by 2.18% at Rs 1,263. While analysts in general have responded positively to TCS’ results, Kotak Securities have downgraded the stock from ‘ADD’ to ‘REDUCE’.
Here are the five reasons why Kotak believes TCS deserves a downgrade:
1.
A slowdown in the sector and lack of consolidation will result in lower pricing pressure and impact profitability of TCS along with the industry.
2.
Substantial reduction in incremental growth opportunity in the existing markets and a collective failure in expanding addressable markets beyond the traditionally strong areas.
3. Increase in Tier-1 players as compared to that 3-4 years back, vying for larger share of the volumes. This mismatch between incremental growth available and higher growth aspiration for existing players is leading to aggressive pricing behavior.
4. TCS’ pricing has
declined in four of the past five quarters, despite the company indicating stable pricing environment. Pricing declined 1.1% quarter-on-quarter in June 2012 quarter.
5. As a result
earnings expectation has been reduced by 1.7-6.0% for FY13 and FY14 and the target price has been cut to Rs 1,125 as compared to Rs 1,280. Currently TCS trades at a valuation of 18.2 times its FY13 expected profit, which is expensive given the backdrop of weak pricing environment and deterioration in industry growth.
Pricing worries cloud outlook for India's IT industry
reuters
(Reuters) -
A squeeze on billing rates is clouding the outlook for India's IT industry, which is feeling the pain of discount demands from its key financial sector clients.
Infosys, India's No.2 software services exporter, said on Thursday pricing fell by 3.7 percent in the June quarter from the previous quarter, and larger rival Tata Consultancy Services (TCS.NS) said prices fell about 1 percent.
B. G. Srinivas, Infosys' head of financial services and Europe, told analysts
the company faced pressure to discount from the financial sector, the firm's biggest client segment.
"When the overall budgets are under pressure, there is definitely a move to get more for less, and in that context, of course, there's competitive pressure as well," he said.
Bhavin Shah, the chief executive of Equirus Securities who forecast that
Infosys would cut its full-year growth forecast to 5 percent, echoed that feeling.
"Given the weak demand environment when everyone obviously competes for a smaller piece of the growth pie, I expect further price erosion in coming quarters," said Shah, formerly a top JP Morgan Asia technology analyst who has an "underweight" rating on the IT sector.
"
We believe that (economic) slowdown and lack of consolidation in the sector will manifest in reduced pricing power and profitability for TCS and the industry," Kotak Institutional Equities analyst Kawaljeet Saluja wrote in a note following the results.
Kotak downgraded both Infosys and TCS to "reduce" from "add."
"This mismatch between incremental growth available and higher growth aspiration for existing players is leading to aggressive pricing behaviour. Our channel checks indicate aggressive pricing by a Tier-1 player. Infosys' pricing decline is also worrying," he wrote.
Infosys and TCS lead India's $100-billion-a-year IT and back-office outsourcing industry, which gets some
three-quarters of its revenue from customers in the United States and Europe.
Economic volatility pushed Infosys to forecast lower-than-expected growth for the full fiscal year on Thursday, sending its shares down 8.4 percent. The shares ended 1.5 percent lower on Friday, while TCS gained 1.1 percent.
TCS, which posted better-than-expected quarterly profits after markets closed on Thursday, expects to beat industry group Nasscom's export growth target of 11-14 percent for this fiscal year, and downplayed concerns about pricing.
"From our side we have not seen the need to reduce the prices," S Mahalingam, TCS's chief financial officer, told Reuters on Friday.
"So far we have not seen any irrational behaviour from any of our competitors," he said.
TCS said its decline in billing rates came from a change in the mix of services sold.
Infosys's weak forecast prompted a slew of price target cuts and a few ratings downgrades.
Infosys's "aggressive pricing and willingness to sacrifice margins should imply either a market share gain for Infosys or a significant pressure on sector margins," Barclays wrote in a note, cutting its rating to equal-weight from overweight.
Deutsche Bank added: "
Infosys's June-Q performance underscores our belief that pricing will come under pressure" in the second half of 2012.
