India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
India Computer Services
2011: India IT to gain steam
India IT to gain steam; up estimates, POs, raise Infy to Buy
We raise our forecasts for Indian IT stocks led by (1) a steep increase in our
2011E US GDP (2) a significant change in our INR/USD forecast and (3) a
continued uptrend in discretionary IT spending. We lift POs also on a roll forward
of estimates. Infy is one of the key beneficiaries of the uptrend in discretionary IT
spending, on higher exposure to enterprise solutions and app development, and
we raise it to Buy. Raise Infotech to Neutral, as revenue visibility improves.
Hexaware amongst mid caps continues to benefit from an uptick in discretionary
IT spend.
HCLT, TCS offer more potential upside than peers
We see the highest potential stock upside in HCLT of 34%, led by a FY11-13e
EBITDA CAGR of 27%, driven by its exposure to discretionary IT services like
enterprise solutions, high growth infrastructure management services (IMS) and
likely margin uptrend from March as investments pay off. TCS offers the second
highest stock upside of 22% led by our estimated 2-yr EBITDA CAGR of 23%, on
greater exposure to the high growth banking vertical, competitive strength in high
growth IMS and scope for a productivity, pricing and mix-led margin surprise.
Macro risks abate; US GDP forecast raised
Over the last two months, our US economist raised his 2011 US GDP forecast
steeply from 1.8% (in September) to 2.8%, with a forecast of further acceleration
in growth to 3.1% in 2012. This upgrade has been led by the new fiscal package,
which adds net new stimulus by extending unemployment benefits and tax
concessions (see our US Economic Weekly: A big dose of caffeine, 10 Dec. ‘10).
Rupee forecast changed; to depreciate beyond March 2011
Our economists have also taken a more constructive view on the USD and thus
our INR/USD forecast for December 2011 has been changed from Rs43/US$ in
November to Rs46/US$. We bake in Rs45 on average for FY12 vs Rs44 earlier.
Continuing positive feedback on demand
On the ground, order flow remains strong, driven by strategic- and regulatoryrelated
discretionary IT spending in sectors such as banking and retail and cost
optimization-related spending by industries like manufacturing. Product
development spending by technology verticals is also picking up. Recent
Accenture and Oracle results confirmed the strong enterprise IT spending
environment. Moreover, offshoring continues to gain share in services like IMS.
2011: India IT to gain steam
Up estimates, POs, raise Infy to Buy
We upgrade forecasts for the Indian IT majors led by (1) macro risks abating
as reflected in the steep increase in our 2011 US GDP forecast from 1.8% in
September to 2.8% in December, (2) a significant change in our Dec. 2011
INR/USD forecast to Rs46/USD from Rs43/USD earlier and (3) a continuing
uptrend in discretionary IT spending driven by strategic- and regulatory-related IT
spending in sectors such as banking and retail and cost optimization-related
spending by industries like manufacturing. Moreover, offshoring continues to gain
share in services like Infrastructure Management Services (IMS).
Consequently we raise POs, also rolling forward estimates. Infy, where we had a
Neutral rating on valuation, is a key beneficiary of the uptrend in discretionary IT
spending, in our view, given higher exposure to enterprise solutions and
application development and we raise Infy it to Buy. Raise Infotech to
Neutral, as revenue visibility improves on recent deal wins. Hexaware amongst
mid caps continues to benefit from uptick in discretionary IT spend.
HCLT, TCS offer more potential upside than peers
While we have Buys on all four Indian IT majors, in our view, HCLT offers
the highest potential upside followed by TCS. Our primary valuation
methodology for the IT stocks remains a trailing 12 months EV/E to two-year
forward EBITDA CAGR (EEG), to minimize the impact of differing timing of tax
hits and volatility in forex hedging related losses/gains.
We see the highest potential stock upside in HCLT of 34% (Table 3), led by a
FY11-13e EBITDA CAGR of 27% and likely margin uptrend led re-rating. Our
earnings forecast is driven by its exposure to discretionary IT services like
enterprise solutions, high growth infrastructure management services (IMS), likely
margin uptrend from March as investments pay off and reducing losses relating to
forex and intangible amortization.
TCS offers the second highest stock upside of 22% led by our estimated 2-yr
EBITDA CAGR of 23%, on greater exposure to high growth banking vertical,
competitive strength in high growth IMS and scope for productivity, pricing and
mix led margin surprise.
We target 15 and 18% 12-month upside in Infosys and Wipro, on our
forecast 2-yr EBITDA CAGR of 21-22%.
Post stock outperformance in the last 1-month, Wipro could underperform peers
near term given client mix related growth challenges & fulfillment issues could
take a couple of quarters to resolve.
Though we forecast Infy to have the highest EPSg next year, on the tax hit being
behind it, the stock upside could be a tad lower than peers due to its steeper
valuation and our forecast of slightly lower EBITDAg given our assumption that
Infy may decide to invest their higher than industry average margin in localization
initiatives and in growing emerging markets like China and services like IMS and
BPO.
Macro risks abate
Over the last two months, our US economist raised his 2011 US GDP forecast
steeply from 1.8% (in September) to 2.8% in December, with a forecast of further
acceleration in growth to 3.1% in 2012.
In November, we raised our US GDP estimates from 1.8% to 2.3% on the back of
an improving employment outlook. In December 2010, we further boosted the US
GDP forecast by 50bp to 2.8%. This upgrade has been led by the new fiscal
package, which not only appears to prevent fiscal tightening but adds net new
stimulus through an extension of unemployment benefits and tax concessions
(See our US Economic Weekly: A big dose of caffeine, 10 Dec. ‘10).
While consensus US GDP forecast has remained relatively steadier, that too
shows a positive bias since October.
Continuing positive feedback on demand
On the ground, order flow remains strong, driven by strategic and
regulatory-related spending by the banking, retail, and media sectors and cost
optimization-related spending by industries like manufacturing. Product
development spending by technology verticals is also picking up.
Recent Accenture and Oracle results confirmed the strong enterprise IT
spending environment. Accenture’s revenue growth of 14% YoY (constant
currency) beat its guidance and consensus. It also raised its full-year revenue
growth guidance to 8-11% (vs 7-10% earlier) on a constant currency basis.
Management commentary highlighted pent-up demand as a driver and stable
pricing.
Oracle also registered a strong quarter, beating consensus estimates on strength
in license demand. Database licenses (a good barometer of overall IT demand),
grew 23% YoY c/c. Application licenses also saw healthy growth of 22% YoY c/c.
Moreover, global sourcing continues to gain share in new services like IMS,
new verticals like healthcare and government, and new markets like Continental
Europe. IMS and BPO are forecast to grow at twice the average offshore market
growth.
Rupee forecast to depreciate beyond March 11
Our economists have also taken a more constructive view on the USD and hence
our INR/USD forecast for December 2011 has been changed from Rs43/US$ to
Rs46/US$. The US seems to be accelerating sharply out of a mid-cycle
slowdown.
On average, we have baked in Rs45 for FY12 vs Rs44 earlier.
Stock Picks
Large caps
While we have Buys on all four Indian IT majors, in our view, HCLT offers
the highest potential upside followed by TCS. Our primary valuation
methodology for the IT stocks remains a trailing 12 months EV/E to two-year
forward EBITDA CAGR (EEG), to minimize the impact of differing timing of tax
hits and volatility in forex hedging related losses/gains.
HCLT: We forecast EBITDA CAGR of 27% over FY11-13E led by (1) IMS and
enterprise solutions (IMS is one of the fastest growing areas driven by market
share gains and Enterprise Solutions should show a pick up led by a rise in
discretionary IT spending) and (2) we believe HCLT should show a margin
uptrend from March 2011 as investments pay off. We believe this should help
rerate the stock from a one-year forward P/E of 14x (FY12E) to 15x (FY13E) and
from an EEG (trailing 12 months EV/E to two-year forward EBITDA CAGR) of 0.4
to 0.5x.
TCS: Forecast 23% two-year EBITDA growth, on the highest exposure to the fastgrowing
banking vertical, its strong competitive position in IMS, new growth areas
like cloud computing, and continued margin focus. We believe TCS could surprise
on margins, helped by mix, productivity and pricing. EPS growth in FY12 is 5%
lower than Infy given differential timing of the expiry of the tax holiday, but
normalizes in FY13. While valuation is toward the upper end both on EEG and
P/E (Charts 6 & 10), given the re-rating last year, EBITDA growth should drive
stock return, in our view.
Infosys: Forecast a 21% two-year EBITDA growth led by the uptrend in
discretionary IT spending boosting enterprise solution and development revenue
and continuing strength in the banking vertical. We have built in a slightly higher
margin decline for Infy vs TCS as it builds out local capabilities and likely invests
in some emerging markets like China and Latin America and services like IMS
and BPO.
We forecast Infy to have the highest EPSg next year, on tax hit being behind.
Most of Infy’s software tech parks completed 10 years from setting up in FY11.
However, stock upside tad lower than peers due to steeper valuation both on
EEG and PE. Earnings growth should drive over 15% further stock return.
Wipro: We forecast 22% two-year EBITDA growth, given the technology vertical
is beginning to pick up and some of the large deal wins in IMS could complete
ramp-up in the next six months. However, post the recent stock outperformance,
Wipro could underperform peers near term given challenges in client mix (eg,
greater exposure to the technology vertical vs banking) and fulfillment issues
could take a couple of quarters to resolve. Client mining efforts are also taking
longer than expected.
Midcaps... PE discount to narrow
Mid cap IT stocks are trading at PE discount of ~55% to Tier one (top 3) Indian
vendors as compared to historical range of 25-30%. We expect PE discount to
narrow given 1) concerns on US economy easing and 2) improvement in revenue
visibility given recent deal wins by companies. Hexaware amongst mid caps
benefiting from an uptick in discretionary IT spend, and as revenue picks up, we
believe Hexaware should report significant expansion in margins during CY11E.
Consequently we have raised estimates & PO and ratings for stocks under our
coverage. We upgrade Infotech to Neutral and retain Buy rating on
Hexaware.
Hexaware : We raise estimates by 2% and 4% for CY11E and CY12E and roll
forward earnings to CY12E. Raise PO to Rs160 at 12x CY12E at ~30% discount
to tier one vendors. We expect Hexaware to benefit from pick up in discretionary
spend ie ERP where it has strong presence in PeopleSoft implementation.
Hexaware also recently announced US$110mn deal, thus improving revenue
visibility for the company. Our PO implies 14x CY11E.
Infotech : We raise estimates by 3% and 6% for FY11E and FY12E and roll
forward earnings to FY13E. Raise PO to Rs190 at 12x FY13E at ~30% discount
to Tier one vendors. While revenue visibility has improved given recent deal wins
from Hamilton Sunstrand and Sea Well Corporation, we believe margin
expansion is likely to be challenging. Upgrade to Neutral. Our PO implies 13x
FY12E.
December 2010 quarter: Reasonably strong…
in line; Positive commentary likely
We forecast around 6-7% QoQ revenue growth in USD terms for the top four
Indian vendors, and 2-3% QoQ all-round growth in INR terms, led by volume.
This is strong for a seasonally weak quarter. Cross currency would aid growth by
50-100bp QoQ. Wipro could underperform on revenue growth due to its client
portfolio and fulfillment issues.
Margins could be sequentially flat (Wipro IT) to around 70bp down (TCS) mainly
due to over 4% Re/USD appreciation.
We expect hiring trends and commentary to be positive given strong demand
momentum for global sourcing of IT services.
Key themes for 2011
Discretionary IT demand picks up
2010 saw demand rebound led by M&A-led integration work in the banking
vertical and cost cutting-related projects in other verticals. 2011 is likely to see
increasing discretionary IT-related spending such as a) on ERP, business
intelligence, analytics b) on technology projects to boost revenue such as
expansion into emerging markets c) on use of technology as a competitive
differentiator such as for trading platforms and d) leverage of technology to adapt
to structural changes in industry such as building online distribution channels and
solutions to facilitate mobility and collaboration. We also hear of a pick-up in R&D
spending and outsourcing by technology software and hardware companies and
consumer electronics.
Pricing could look up
We expect pricing to look up both on a like-for-like basis as contracts come up for
renegotiation and pricing concessions made last year are reversed. Moreover,
discretionary IT-related work usually has better pricing and thus realization should
improve.
Cloud consulting an incremental opportunity
We believe 2011 will see acceleration in cloud consulting and systems integration
assignments as large enterprises explore private cloud options for IT
infrastructure and applications.
Year of M&A
During the recession, vendor consolidation trends have picked up as clients’ aim
to gain from scale economies and look at integrated business results. At the
same time, top 3 Indian IT vendors are sitting on US$1-4bn cash, and have
numerous expansion initiatives into new geographies, verticals and service lines
like IMS and need to develop cloud offerings. This should accelerate M&A.
Infosys has the highest net cash of nearly USD4bn.
Globalization initiatives to pick up
We also expect 2011 to see acceleration in growth of local employees in
geographies outside India, as protectionism initiatives continue given high
unemployment rates. This could pressure margins.
Investment thesis
HCL
We like HCL Tech for its favorable exposure to the rapidly growing Infrastructure
Management Services. We also expect it to be a key beneficiary of the increased
spends in R&D services and enterprise solutions, as discretionary spending
returns. Moreover we expect investments in sales, BPO and enterprise solutions
to start paying off in 2011. This should lead to stock re-rating. Sharply reduced
forex losses and intangible amortisation charge to further boost earnings growth.
Infosys Tech
Infosys should be a key beneficiary of increased global sourcing and the uptrend
in discretionary IT spending, particularly in enterprise solutions. EBITDA growth
could be a tad lower than peers if Infosys decides to ramp up investments in
growing local delivery capability and developing new growth markets. However,
Infosys should report the highest FY12 EPS growth among peers, given the tax
holiday expiry hit is behind them this year. Revenue led strong earnings growth
should drive stock upside
Infotech Enterprises Ltd
While Infotech is well positioned to benefit from long term growth prospects in
engineering design especially aerospace and rail we remain cautious on recovery
in margins for the company. While revenue visibility has improved given recent
deal wins in engineering services business, we believe valuations provide limited
upside to stock from current levels.
Tata Consultancy
TCS should be a key beneficiary of the uptrend in discretionary IT spending and
increased global sourcing, particularly in the banking, financial services and
insurance vertical. We also like TCS for its strong competitive position across
service lines including high growth areas like Infrastructure Management
Services. We expect pricing, productivity and revenue mix focus to largely offset
wage pressures.
Wipro
We like Wipro for its favorable position in growth areas of infrastructure
management services and BPO. Also, we believe the telecom and hi-tech
verticals which have been a challenge for them have bottomed. Investments in
strengthening the sales and hiring engines should pay off in a couple of quarters.
Price objective basis & risk
HCL (XHCLF)
Our Price Objective of Rs620 assumes re rating from a one-year forward (FY12e)
P/E of 14x to 15x FY13 earnings estimate, as margins bottom. We believe this is
justified as it implies a conservative FY12 EV/EBITDA to 2yr EBITDA growth of
0.5x, a discount of over 30% to Wipro' s target EEG. Downside risks stem from
higher than expected investments delaying margin recovery, macro led delays in
discretionary IT spending, higher than expected wage hike pressures and Rupee
appreciation.
Hexaware Tech (XFTCF)
Our PO of Rs160 is at 12x CY12E at approx 30% discount to tier one vendors
given high revenue concentration and exposure to discretionary spends like ERP.
We expect the stock to re-rate on back of improving revenue visibility and
turnaround in margins.
Downside risks: Slower-than-expected margin expansion, risk to PeopleSoft
implementation revenues, and industrywide risks of growing competition, wage
pressures and Rupee appreciation. Upside risks: Large deal closures currently
being pursued by the company.
Infosys Tech (INFYF)
Our Price Objective of Rs4,000 (US$87 for ADR, at parity) is based on a target
FY12 EV/EBITDA to 2yr EBITDA growth of 0.85x, in-line with its 5yr avg multiple.
This implies a FY13e P/E of approximately 22x, broadly in line with current 1yr
forward (FY12e) PE. Downside risks to estimates stem from macro led delays in
IT spend or sharp appreciation of the Rupee.
Infotech Enterprises Ltd (IFKFF)
Our PO of Rs190 is at 12x FY13E at approx 30% discount to Tier one vendors.
Risks to our price objective and estimates are the following: 1) non-annuity
revenues in GIS, 2) increasing competition from large Indian IT vendors, 3) rupee
appreciation and industry-wide wage inflation.
Tata Consultancy (TACSF)
Our Price Objective of Rs1,400 is based on a target FY12 EV/EBITDA to 2yr
EBITDA growth of 0.85x, in line with Infosys. This implies a target FY13e PE of
22x, in-line with current 1-yr forward (FY12e) PE. Downside risks to estimates
stem from macro led delays in IT spend or sharp appreciation of the Rupee.
Wipro (WIPRF)
Our Price Objective of Rs570 is set at a target FY12 EV/EBITDA to 2yr EBITDA
growth of 0.77x, at a 10% discount to Infosys. This implies a target FY13e PE of
18x, at about 15% discount to Infosys, in line with its 3-yr average discount.
Downside risks to estimates stem from delays in recovery of IT spending by
technology and telecom verticals and success in client mining efforts, apart from
macro risks relating to IT spending and Rupee.
No comments:
Post a Comment