TCS and Infosys - The Value Stock?

In the last 20 yrs, India has emerged as the new face of IT outsourcing hub. The IT sector has created the saga of a more empowered middle class which in turn has resulted in a booming GDP growth of world’s second most populous country.  It is still early to say what would be the future growth of this sector. Mostly dependent on US and European markets, IT sector has faced challenges over the last few years but the investor's penchant for IT stocks have been up-beat.  Let’s take some of the key IT stocks in Indian market and where they stand

 

The two top Blue chips from IT sectors are TCS and Infosys. Both the companies employ in access of 150,000 people and has been the success stories for India’s IT boom. The two sister companies were moving parallel until TCS took the lead. As an investor, this always confuses me which of the two has more promise for future growth. Infosys which is trading at a PE multiple of 15, has a huge cash balance of USD 4 Billion, while TCS is trading at a higher PE and also retaining the number one spot in IT outsourcing space globally. Let’s compare their highs and lows over last 1 year.

 

As we can see, both the companies have shown similar gaps in the highs and lows over the last year and any investor could have found the opportunity to be 50% richer, had they bought them at right levels.  So the million dollar question is “what is the right level and how the valuation can be affected with the changing economic landscape?”

The average growth in sales and operating margin for the two companies over last 5 years are:

 

Recently, Cognizant has replaced Infosys from no. 2 position. While Investors have always been critical of Infosys operating model, the company has managed to maintain a healthy operating margin at the cost of a slow growth in its top line compared to its peers. So let’s see what should be the ideal valuation of these two stocks and the probable scenarios which may affect future valuations.  I have taken four scenarios here:

Case1:  The next 10 year growth remains similar and the operating margin is maintained

Case2:  The next 10 year growth slows down moderately

Case3:  There is a gradual decline in top line due to competition and bleak economy outlook

Case4:  There is a change in operating model and the company sees a sharp growth

The valuations of the stocks in the above 4 cases are:

 

Based on the analysis, I feel that Infosys is a better choice compared to TCS. Firstly, its present valuation is more attractive as the true valuation can be around 2400 INR.  While TCS has shown a surge in valuation, I don’t think that the present level of INR 1400+ is sustainable even with the best possible growth prospects.  Also, compared to Infosys, TCS has a smaller Beta and hence the implied risk premiums associated with it comes to be lower. In case the beta moves up, we can see a drop in prices. The reason why TCS is trading above par is mainly due to the uncertainty with its other peers in this sector.

To summarize, I would still go long Infosys as I see value in the stock. My fair estimate for the stock is INR 2400. Hence any drop from the present level should definitely provide a buying opportunity .