Forex Exposure in Indian IT companies

1 Edelweiss Securities Limited

A comparison of FY13 annual reports of Infosys and TCS presents varying trends on various critical metrics between the two IT behemoths. While Infosys follows a stable and conservative hedging policy (only forwards), TCS’ hedging policy is varied (forwards + options). Hedges, as a proportion of revenue, is lower for Infosys vis‐à‐vis TCS, which is likely to favour the former in an INR depreciating scenario. Infosys ranks better on disclosure parameters, translation of earnings into cash, margin stability, whereas TCS ranks better in terms of earnings growth, tax efficiency and dividend payout. While Infosys’ cash surplus is primarily in fixed deposits/mutual funds, TCS’ cash surplus also represents non convertible debentures (NCD) and inter‐corporate deposits (ICD), resulting in higher yields.

Key Highlights

Derivatives and hedges

The two companies follow different hedging proportions and strategies. We

believe Infosys has a stable and consistent hedging strategy vis‐à‐vis TCS; the latter

has a varied policy for hedging its currency risk. TCS has mix usage of options and

forward contracts as hedging instruments, while Infosys has only foreign currency

forward contracts.

Higher coverage in FY12 led to higher derivative losses for TCS; part of losses was

recognised in hedging reserves. TCS recognises portion of gains/losses on

derivative contracts in reserves, being designated as effective cash flow hedges,

and balance in P&L. Infosys booked all gains/losses in P&L as all the hedges were

considered ineffective.

Quality of accounting policy disclosures

Quality of Infosys’ accounting policy disclosures was observed to be better. The

company provides exhaustive disclosures in the annual report related to revenue

recognition, post‐sales support costs and warranties. TCS did not specifically provide

disclosures on the above items.

Translation of earnings into cash

Conversion ratio of earnings into cash flow was consistently higher for Infosys

compared to TCS. Cash conversion ratio dipped in FY11 for both the companies,

however Infosys recovered quickly vis‐à‐vis TCS. Average collection period was

consistently lower for the former versus TCS.

Edelweiss research is also available on www.edelresearch.com, Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Edelweiss Securities Limited

ANALYSIS BEYOND CONSENSUS…THE NEW ABC OF RESEARCH

TCS vs Infosys | Annual Report Analysis

Analysis beyond Consensus (ABC) is our initiative to provide a differentiated perspective to our clients on various non‐routine and intricate issues. This unit of research works independent of the sector/stock research team and views expressed in this report may vary with that of respective sector/stock analyst.

Manoj Bahety, CFA

+91 22 6623 3362

[email protected]

Sandeep Gupta

+91 22 4063 5474

[email protected]

July 8, 2013


Annual Report Analysis

Cumulative cash generation and disposal

TCS paid out higher amount of cash on acquisitions and paying dividends to shareholders

compared to Infosys during the past five years. Cash held as a percentage of net worth is

significantly higher for Infosys vis‐à‐vis TCS.

Investment yields

TCS generated better yields on average cash and investments for three years since FY11,

especially in FY13, due to investments in high yielding corporate debentures issued by

parent company Tata Sons and its subsidiaries (12% of surplus cash is invested in NCDs

issued by group companies).

Score card (Based on our assessment)

Source: Company annual report, Edelweiss research

Hedging proportion and strategy Hedging coverage as percentage of average revenue is higher for TCS compared to

Infosys. However, the proportion has been varying in case of TCS, whereas for Infosys it

has been stable and consistent (between 10% and 15%) over the past five years.

Hedging cover as % of average revenue

Source: Company annual report, Bloomberg, Edelweiss research

Parameters TCS Infosys Remarks

Derivatives and hedging Stable derivative coverage and consistent hedging policy

by Infosys

Disclosure quality Detailed policy disclosures by Infosys

Earnings translation into cash flow Consistently higher conversion ratio

Cash flow growth and utilisation Higher spends on acquisitions, paying dividend and lower

cash held on books by TCS

Revenue and PAT growth Higher growth YoY compared to Infosys

Revenue & PAT per employee Consistently high per employee metrics for Infosys

PAT & EBITDA margins Higher margins maintained by Infosys

Dividend payout TCS paid higher dividends in five years except in FY11

RoE composition Consistently higher for TCS in 5 years

Investment yield Higher for TCS due to high yielding investments

Effective tax rate Lower tax rate maintained for past four years

35.0

41.2

47.4

53.6

59.8

66.0

7.0

16.6

26.2

35.8

45.4

55.0

FY09 FY10 FY11 FY12 FY13

(USD

/INR)

(%)

TCS (%) INFY (%) USD/INR

Varying hedging proportion and

strategy observed between the

two companies. Infosys has a

stable and consistent hedging

strategy vis‐à‐vis TCS.


TCS Vs Infosys

Derivative instruments used for hedging firm commitments/ forecast sales transactions.

TCS enters into contracts ranging from 1 day to 8 years and has a mix of both foreign

exchange forward contracts and foreign currency options contracts. The proportion has

been varying year on year. Due to options contract, the company will benefit from

favourable exchange rates movements.

Infosys enters into contracts maturing between 1 and 12 months. Outstanding

exposure as at March 31, 2013, and past three years’ data reveals that use of options

has been discontinued and hedging strategy is to use only foreign exchange forward

contracts. Absence of options contracts results in lower hedging cost; however, it limits

the company’s ability to benefit from favourable exchange rates movements.

Forwards and Options mix Forwards and Options mix


Accounting of derivative gains/ losses Both TCS and Infosys have adopted ‘AS‐30 – Financial Instruments: Recognition and

measurement’. Consequently, TCS records MTM gains/ losses directly in reserves for all

effective hedges designated as cash flow hedges.

Infosys routes all gains/ losses through P&L because the disclosure in the company’s

financial statements states that currently hedges taken by the group are ineffective and

hence resultant gains/ losses consequent to fair valuation are recorded directly in the profit

and loss account.

0%

20%

40%

60%

80%

100%


TCS

Forwards ‐Cash flow hedges routed through reserves

Options ‐Cash flow hedges routed through reserves

Forwards and Options ‐Routed through P&L

0%

20%

40%

60%

80%

100%


Infosys

Forwards Options

TCS posted higher amount of

derivative losses in FY12

compared to Infosys on account

of higher derivative cover.

Infosys, due to low derivative

coverage, posted lower losses in

FY12 and booked a gain in FY13

on derivative contracts.



Derivative gains/ losses reported in financial statements and notes to accounts by TCS and

Infosys

Derivative Gains/ (Losses) Derivative Gains/ (Losses)


*(FY09 and FY10 figures for Infosys are based on standalone financials as consolidated numbers

are not available)

Comparison of accounting policy disclosures Quality of Infosys’ accounting policy disclosures was observed to be better than TCS.

Accounting policies


(11.0)

(7.0)

(3.0)

1.0

5.0

9.0


(INR bn)

TCS

Derivative Gain/ (Loss) recorded in P&LDerivative Gain/ (Loss) recorded in Reserves

Accounting policies Observations

Revenue recognition Infosys has provided fairly detailed policy disclosure for revenue recognition. The accounting

policy for revenue recognition includes specific mention on volume discounts and pricing

incentives to customers, estimates involved in assessing the amounts and basis of allocation to the

underlying revenue transactions.

TCS revenue recognition policy is very broad in nature and lacks specific disclosures on volume

discounts, incentives and extent of estimates involved in recognising these costs.

‐ Details of amount involved was not separately disclosed by both the companies.

Post sales client

support and warranties

Infosys separately discloses its policy for recognition of post‐sales support costs and warranties

provisions. It estimates such costs on basis of historical experience and estimates are reviewed

annually for any material changes.

‐ FY 13 Provision for post sales client support and warranties stood at INR0.8bn (FY12 INR0.6bn)

‐ Cumulative provision for post‐sales client support and warranties was at INR2.13bn (FY12 ‐

INR1.33bn)

TCS does not provide any such specific disclosures regarding warranties/ sales support costs.

‐ No specific details available on costs incurred.

(8.0)

(5.6)

(3.2)

(0.8)

1.6

4.0


(INR bn)

Infosys

Derivative Gain/ (Loss) recorded in P&L


TCS Vs Infosys

Earnings to cash conversion Conversion ratio of earnings to operating cash flow pans out consistently better for Infosys than TCS.

A) Translation of adjusted EPS to operating cash flow per share.

Cash flows analysis (INR bn)


Earnings to cash conversion ratio (%) % of Adj. EPS (Excl. Other income)


Infosys’ ratio has been consistently higher in the past five years, whereas TCS’ conversion

ratio deteriorated, especially FY11 onwards, primarily due to increase in trade and other

receivables. TCS also has exposure to government sector/ vertical which was one of the

drivers of incremental growth in 2012.

Particulars FY09 FY10 FY11 FY12 FY13 FY09 FY10 FY11 FY12 FY13

Net cash from operating activities 54.1 74.1 66.4 69.8 116.2 53.3 61.9 47.5 63.1 73.7

Interest expenses paid (0.3) (0.2) (0.3) (0.2) (0.5) ‐ ‐ ‐ ‐ ‐

Net cash from operating activities post interest 53.8 73.9 66.1 69.6 115.7 53.3 61.9 47.5 63.1 73.7

Operating cash flow per share (OCFPS) 27.5 37.8 33.8 35.5 59.1 93.0 108.4 83.2 110.4 129.1

EPS (Reported) 26.8 35.7 46.3 53.1 71.0 104.6 109.0 119.7 145.8 165.0

Other income per share (2.2) 1.4 3.1 2.2 6.0 16.0 16.6 21.2 33.3 41.4

Adj EPS (Ex‐Other Income) 29.0 34.3 43.2 50.9 65.0 88.6 92.4 98.5 112.5 123.6

Adj EPS (Excl other income) Represented by OCFPS(%) 94.7 110.1 78.2 69.8 91.0 104.9 117.2 84.5 98.1 104.4

TCS Infosys

50.0

66.0

82.0

98.0

114.0

130.0


(%)

TCS Infy


TCS 94.7 110.1 78.2 69.8 91.0

Infy 104.9 117.2 84.5 98.1 104.4



Average collection period Receivable days


Receivables collection days continued to be higher for TCS.

B) Cumulative cash flow generation and utilisation analysis over past 5 years (FY09‐13)

Sources of cash

Net operating cash flow generation has been lower for Infosys on cumulative basis

in the past five years compared to TCS. Relative proportion of dividend, interest

and other income is also significantly larger for the former than the latter.

Sources of cash generation from 2009 to 2013


Utilisation

Both the companies invested nearly equal amounts in fixed capital. TCS has a

larger percentage of dividend payment compared to Infosys. Cash held on books as

percentage of total cash generated continues to be significantly large for Infosys. In

terms of spending on acquisitions, TCS spent more than Infosys in the past five

years. TCS has also larger percentage of funds invested in fixed deposits and short/

long term investments vis‐à‐vis Infosys.

43

52

61

71

80

89


(Days)

TCS Infy

Net Operating Cash flows

95%

Investment Income5%

TCS


TCS 73 69 69 74 74

Infy 59 58 54 57 59

Net Operating Cash flows

81%

Investment Income19%

Infosys


TCS Vs Infosys

Cash utilisation as percentage of cash generation from 2009 to 2013


TCS ‐ YoY cash generation and utilisation—FY09 to FY13 (INR bn)


TCS’ cash flow posted 17% CAGR over past five years

Infosys ‐ YoY cash generation and utilisation—FY09 to FY13 (INR bn)


Infosys’ cash flow posted 8% CAGR over past five years.

Capex21%

Acquisition6%

Purchase of minority interest1%

Dividend45%

NCDs and ICDs12%

Net debt repaid1%

Net cash surplus/ (deficit)14%

TCS

Sources FY09 FY10 FY11 FY12 FY13 Total Application FY09 FY10 FY11 FY12 FY13 TotalOperating profit 64.3 88.3 110.7 145.0 182.0 590.4 Capex 11.0 10.3 18.1 19.9 26.3 85.6

Less : Interes t 0.4 0.2 0.3 0.2 0.5 1.5 Acquis i tions 24.4 (0.3) (0.3) ‐ 1.6 25.5

Less : Taxes 12.1 19.1 22.6 40.7 48.2 142.7 Purchase of minori ty int. ‐ ‐ ‐ 2.3 ‐ 2.3

Add: Inves tment Income 2.1 1.1 4.1 4.3 8.1 19.6 Dividend 16.1 19.7 46.1 39.1 57.4 178.3

Cash profits 53.9 70.2 91.9 108.4 141.4 465.8 NCDs and ICDs 0.8 13.9 0.4 3.8 27.4 46.3

Working capita l changes 1.9 4.8 (21.9) (34.6) (17.7) (67.5) Net debt repaid 0.3 4.0 0.2 0.3 (0.8) 4.1

Cash profits after working cap 55.8 75.0 70.0 73.8 123.7 398.3 Miscel laneous (0.1) (0.1) (0.1) 0.0 0.2 (0.0)

Equity 0.0 0.1 0.0 0.1 ‐ 0.2 Net cash and investments 3.4 27.4 5.6 8.5 11.6 56.5

(FDs , Mutual funds)

Total 55.8 75.0 70.0 73.9 123.7 398.5 Total 55.8 75.0 70.0 73.9 123.7 398.5

Sources FY09 FY10 FY11 FY12 FY13 Total Application FY09 FY10 FY11 FY12 FY13 TotalOperating profit 66.9 80.1 90.3 108.4 118.5 464.2 Capex 13.3 6.7 13.1 15.3 20.9 69.2

Less : Interes t ‐ ‐ ‐ ‐ ‐ ‐ Acquis i tions 0.2 1.7 0.0 2.0 11.6 15.5

Less : Taxes 9.0 17.5 28.5 31.2 32.9 119.1 Dividend 24.9 15.7 36.6 23.3 31.2 131.8

Add: Inves tment Income 10.6 8.7 11.5 18.1 19.7 68.6 Net debt repaid ‐ ‐ ‐ ‐ 0.9 0.9

Cash profits 68.4 71.3 73.3 95.4 105.3 413.6 Net cash and investments 26.1 47.4 9.5 40.7 28.9 152.6

Working capita l changes (4.6) (0.6) (14.3) (14.2) (11.8) (45.5) (FDs , Mutual funds)

Cash profits after working cap 63.8 70.8 59.0 81.2 93.4 368.2

Equity 0.6 0.9 0.2 0.1 0.0 1.8

Total 64.5 71.6 59.2 81.3 93.4 370.0 Total 64.5 71.6 59.2 81.3 93.4 370.0

Capex19%

Acquisition4%

Dividend36%

Net cash surplus/ (deficit)41%

Infosys



PBT growth versus cash flow growth

Growth in cash flow from operations versus PBT has been unstable for TCS, except for FY10

when it was almost equal. For Infosys, cash flow growth has been in line with PBT growth,

except for FY11 when it was negative due to significant increase in receivables and taxes

paid.

PBT and Cash flow growth PBT and Cash flow growth


PAT and EBITDA margins

Despite TCS’ better revenue growth in FY13 vis‐à‐vis Infosys, the latter’s profit margin

continued to be better. Infosys’ EBITDA margin has been higher than TCS except in FY13

where it is almost equal for both the companies.

PAT margin EBITDA margin


(20.0)

0.0

20.0

40.0

60.0

80.0


(%)

TCS

PBT (% growth YOY)

Cash flow from operations (% growth YOY)

17.0

19.5

22.0

24.5

27.0

29.5


(%)

TCS INFY

(28.0)

(14.0)

0.0

14.0

28.0

42.0

FY09 FY10 FY11 FY12 FY13(%)

Infosys

PBT (% growth YOY)Cash flow from operations (% growth YOY)

22.0

26.0

30.0

34.0

38.0

42.0


(%)

TCS INFY


TCS Vs Infosys

Revenue and PAT per employee

Revenue per employee and PAT per employee continues to be higher for Infosys vis‐à‐vis

TCS.

Revenue per employee PAT per employee


Dividend payout ratio

Dividend payout has been higher for TCS in past five years, except for FY11, compared to

Infosys. FY11 increase in dividend for Infosys is on account of special dividend on completion

of 30 years. Dividend payout (%)


0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

FY11 FY12 FY13

(INR mn)

TCS INFY

0.0

0.6

1.2

1.8

2.4

3.0

FY11 FY12 FY13

(INR mn)

TCS INFY

0.0

12.0

24.0

36.0

48.0

60.0


(%)

Infosys

TCS INFY



ROE analyser TCS continues to exhibit higher ROE as compared to Infosys; however latter has higher

return on operating assets (RNOA) as revealed by ROE analyser below.

ROE comparison


RoE analyser analysis profitability on the scale of operating and capital allocation efficiency

(detailed concept explained in Annexure A). We have analysed TCS’ and Infosys’ profitability

for FY13, results and key findings of which are given below:

TCS – ROE analyser

* Net financing income is based on closing average figures (Refer Annexure A for details)

21.0

27.0

33.0

39.0

45.0

51.0


(%)

TCS INFY

Particulars

A. Return on net operating assets (RNOA) 42.1

OPATO (operating asset turnover) (x) 2.0

NOPAT margin (%) 21.0

B. Return from leverage (FLEV x spread) (%) (5.2)

FLEV (financial leverage) (x) (0.2)

NFI (net financing income) (%) 12.5

Net financial spread (RNOA ‐NBC) (%) 29.6

C. Return from other funding (%) 0.3

ROE Derived (A+B+C) (%) 37.1

FY13


TCS Vs Infosys

ROE tree ‐ TCS


Infosys – ROE analyser

* Net financing income is based on closing average figures (Refer Annexure A for details)

ROE tree ‐ Infosys


‐4.9

0.3

42.0 37.4

0.0

9.0

18.0

27.0

36.0

45.0

RNOA Return from leverage

Return from other funding

ROAE

(%)

Particulars

A. Return on net operating assets (RNOA) 50.8

OPATO (operating asset turnover) (x) 2.6

NOPAT margin (%) 19.4

B. Return from leverage (FLEV x spread) (%) (25.1)

FLEV (financial leverage) (x) (0.6)

NFI (net financing income) (%) 7.4

Net financial spread (RNOA ‐NBC) (%) 43.5

C. Return from other funding (%) ‐

ROE Derived (A+B+C) (%) 25.7

FY13



Yield on investments The increase is FY13 seems to be primarily on account of investment in high yielding non‐

convertible debentures issued by parent company Tata Sons and its subsidiaries (interest

ranging from 8.5% to 9.5%) and investment in other debentures and bonds.

Yields on average cash and investments


Effective tax rate TCS’ effective tax rate has been consistently lower in past four years compared to Infosys. Effective income tax rate(%)


0.0

3.2

6.4

9.6

12.8

16.0


(%)

Infosys

TCS INFY

0.0

7.0

14.0

21.0

28.0

35.0


(%)

Infosys

TCS INFY

Infosys’ cash and investments

as % of net worth is significantly

high at 59% as compared to TCS’

20%.

Further, TCS generated better

returns on cash and investments

compared to Infosys.


TCS Vs Infosys

Geographical revenue split

US and Europe contribute significantly to revenues of both TCS and Infosys. While revenue

contribution from US has been flattish for TCS, US revenue growth dipped marginally in case

of Infosys.

Revenue contribution (%) Revenue contribution (%)


0%

20%

40%

60%

80%

100%


(%)

TCS

Americas Europe India Others

0%

20%

40%

60%

80%

100%

FY09 FY10 FY11 FY12 FY13(%)

Infosys

North America Europe India Rest of the World



ANNEXURES


TCS Vs Infosys

Annexure A – ROE analyzer

ROE analyser analyses the profitability on the scale of operating efficiency and capital

allocation efficiency. While operating efficiency is a measure of how efficiently the company

is making use of operating assets, capital efficiency is the measure of balance sheet

efficiency.

The above analysis involves:

1. Dissection of profitability along two major drivers:

a. Return from operating activities (RNOA: return on net operating assets).

b. Return from financing activities (leveraging effect on ROE).

ROE = Return from operating activities (RNOA) + Return from leverage

Or

ROE = Operating margin x Operating assets turnover + Leverage spread x Leverage

multiplier

Whereas:

RNOA = NOPAT/Average operating assets

Operating margin = NOPAT/Operating revenue

Operating assets turnover = Operating revenue/Average operating assets

Leverage spread = RNOA – Net borrowing cost

Leverage multiplier = Average net financial obligation/Average common shareholders’

equity

2. Reformulation of balance sheet, wherein we have regrouped assets and liabilities into

operating and financing categories (against traditional current and non‐current

categorisation).

3. Reformulation of income statement, wherein we have regrouped income and expenses

into operating and financing activities.



Summary financials

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TCS Vs Infosys

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Forex Exposure in Indian IT companies

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