Macquarie : India IT Services US demand set to rise faster in FY12

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India IT Services
US demand set to rise faster in FY12
Event
 Macquarie US economist Rebecca Hiscock-Croft has upgraded her US GDP
growth forecast to 3.5% for next year from 2.6% (consensus: 2.5%). Positive
economic data pointing and the recently announced new tax deal should add
to both consumption and business investment growth in FY12, in our view.

Impact
 ISM Manufacturing Index is at its highest since May. The ISM
Manufacturing Index, a purchasing managers’ survey, is one of the key
measures of business conditions in the US economy. The index is based on
responses from individuals within the economy who are actually purchasing
goods, thus it provides an extremely insightful view into where the economy is
heading. The index is designed so that measures above 50 indicate economic
expansion, while those below 50 signal contraction. The index came in at 56.9
in November, which is its best level since May. For comparison, the 10-year
average stands at 51.2
.
 Indian IT services is the winner from increased US corporate spend. Our
Macquarie quantitative analysts have forecasted the ISM index to be in the
mid-cycle acceleration phase next year (Fig 2). Historically, hardware and
software services stocks outperform the market and are amongst the top five
gainers during this phase (Fig 3). This stock price performance follows
positive business momentum for these companies as corporates loosen purse
strings to refresh aging corporate software base. This should bode well for
Indian IT companies providing software services.

 US capex spend at historic lows. Our US economics team expects a capital
expenditure “catch-up” to provide a solid tailwind for US GDP growth in 2012.
Strong US corporate revenues and earnings, increasingly available low-cost
capital, depreciated capital bases and low capex/sales ratios will likely lead to
increased spends on IT (Figs 4 and 5). US firms also have increasingly large
cash balances on their balance sheets – for example, US non-financial firms’
money market mutual fund holdings more doubled from US$300bn in 1Q03 to
more than US$700bn in 4Q08.

Outlook
 Maintain positive view on sector growth. Indian IT stocks have rallied
strongly on a YTD basis (TCS up 45% and INFO up 22%) as investors have
ample confidence on FY11 demand resurgence. The US corporates will enter
their next year budgeting exercises in January and the data released points to
an optimistic demand outlook for Indian IT services for FY12. We are factoring
in a 27%+ US$ revenue growth for Tier 1 players. Amongst tier 2 vendors,
HCLT is our preferred pick to play the rise in discretionary spend.