Citi :IT Services: 2011 Sector Outlook

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2010 In Line with Market; 2011?
 Similar to 2010 — 2010 has been a “neutral” year for Indian IT – the BSEIT
index has performed in line with the Sensex. With pent-up demand
normalizing and expectations running high, we don’t see scope for
meaningful upside. The sector could be a good defensive if there is a sharp
correction in markets.


 Five key variables for 2011 stock performance… — 1) 2011 IT budgets –
clarity only by Jan'11 – we expect 1-2% increase yoy; 2) Strength of pent-up
demand, behind growth surprises over last few quarters, is expected to
normalize going forward; 3) Pricing uptick is expected but unlikely to be
enough to mitigate supply-side pressures; 4) Supply-side – attrition likely to
remain at high levels and double-digit offshore wage hikes can’t be ruled
out; 5) INR is always a wild card.
 …and a few more — 1) BFSI growth – M&A related spend helped – growth
likely to taper to more normal levels; 2) Discretionary spend – remains a key
variable to watch out for – last few quarters have been strong; 3) Non-
Linearity/Cloud Computing – important from medium term but unlikely to
have a big impact in 2011; 4) Margins – likely to trend down with supplyside
challenges.
 HCLT top pick in the sector — We find valuations at ~13x FY12E EPS
attractive – with margins bottoming and growth profile still strong (expect
~27% revenue ($-terms) CAGR over FY10-12E), we believe a re-rating is
likely over the next 3-6 months. HCLT is our top pick in the sector.
 Infosys a relatively better defensive — Infosys’ demonstrated cost
optimization ability should result in higher investor comfort in a tough supply
side/appreciating INR scenario. The company lost only ~35bps in margins
over FY03-10.