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We believe FY12 is likely to be another 26-30% growth year for tier I vendors as was the case in FY11. Interactions with industry players and channel partners suggest that FY11 growth being driven by cost-outs along with gradual spending towards revenue productivity is a sustained and structural increase in demand for offshore services. Growth in FY12 will be driven by: (a) greater offshoring by existing client base; (b) market share increase for Indian IT players in the renewal deal market; and (c) sustained improvement in IT spending i.e., revival and embracing off shore market.
Upfront discretionary commitments in CY11 budgets
CY11 IT budgets are likely to see greater offshore spending with significant commitment on discretionary spending. Conventional cost take out continues to drive growth for services like IS, BPO, ADM while revenue enhancement is driving spend in Enterprise Solutions (ES), consulting and Package Implementations (PI). We anticipate discretionary spend commitments from large clients to drive visibility for tier 1 companies (TCS, Infosys, Wipro and Cognizant) going into CY11/FY12.
What to expect from December quarter?
Barring the impact of fewer working days during the December quarter, performance is expected to be similar to Q2FY11. The trend of stable pricing and high attrition will remain unchanged. While broadening of the employee pyramid will be favourable, INR appreciation against USD and GBP will be a margin headwind.
Revising up FY12 forecast and introducing FY13 estimates
We are revising up our FY12 USD revenue growth forecast from 21-23% to 26-30% for TCS, Infosys and HCLT, and from 20% to 22% for Wipro. The resultant increase in EPS varies from 1.5% to 6.5% across companies. For tier II companies, our FY12 revenue forecast is unchanged while tweaking the margin assumption leads to 2-4% downward revision for Patni and Infotech.
We also introduce FY13 forecast for our coverage universe. We factor in a 17-21% USD growth for top 4 companies (from TCS to HCLT) and 15-20% growth for mid-tier players (refer table 4 on page 6).
Outlook and valuations
The IT index has outperformed the benchmark index (BSE Sensex) by 14% in the past six months. With continued traction in business and upgrades in earnings, we expect the outperformance to continue. We continue to prefer TCS (BUY) over Infosys and upgrade HCLTto ‘BUY’. We believe better client mining, aggressive sales approach in renewal deal market and improving margins will lead to narrowing of HCLT’s valuation discount to TCS and Infosys. We maintain ‘HOLD’ recommendation on Infosys and Wipro (refer table 5 for detailed recommendations).
Re-rating in mid-caps is imminent and will continue to be selective (like in Hexaware, our erstwhile top pick) and not broad based.
Top picks: TCS and HCLT in large caps and Infotech in mid caps
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