UBS: Indian IT Services:Strong quarter ahead, but priced in

Indian IT Services:Strong quarter ahead, but priced in


􀂄 Volumes should reflect strong demand growth
We expect Q2 FY11 to be a strong quarter in terms of volume growth for Tier I
vendors in the sector, with broad-based growth across multiple verticals and
geographies. We expect Infosys Technologies (Infosys) to lead with 8% QoQ
volume growth among the Top 3 companies, while Tata Consultancy Services
(TCS) is likely to slow to 6.5% QoQ after a strong Q1 FY11.
􀂄 Favourable FX rate should ease margin concerns for most companies
We estimate an average depreciation of 2.6%-2.8% in the currency basket for Tier
I vendors, which is likely to boost reported rupee revenue and ease margin
pressure. We estimate Infosys will report a 145bp increase in its operating margin,
while HCL Technologies (HCL Tech) is likely to report a 150bp decline due to
wage hikes during the quarter. We expect operating margins for Wipro and TCS to
remain relatively stable in Q2 FY11.
􀂄 Infosys guidance upgrade likely, we expect no surprises
Our FY11 EPS estimate for Infosys (Rs123.3) is 5.6% above the high end of
Infosys’ guidance (Rs112.21), and we expect the company to raise its revenue and
EPS guidance by 3%-4% on a full-year basis based on an outperformance in Q2
FY11. We also expect Wipro to guide for strong Q3 FY11 revenue growth.
􀂄 We remain cautious; upsides look fully factored into current share prices
We believe a strong Q2 FY11 performance is already factored into the share prices.
We think there is potential for downside, mainly due to currency appreciation as
seen over the past one to two weeks. We remain cautious on the sector with
Neutral ratings on TCS and Infosys, and Sell ratings on Wipro and HCL Tech.