Please Share:: 
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
IT services Q3FY11: strong quarter; supply still a concern
The Indian IT services sector is witnessing healthy demand traction, led by an improving macroeconomic
environment. With most of key leading indicators suggesting recovery is under way in the US and economic
expansion is gaining momentum, discretionary IT spend is returning in all major segments. European concerns have
not affected business on the ground, though European revenue growth lags that of the Americas in constant currency
terms. Management commentaries indicate that CY11 IT budgets are expected to grow 2-3%. Despite Q3FY11 being
seasonally weak, all Tier1 companies saw volume growth of ~4% qoq and USD revenue growth of 5.5-7.5% qoq. Even
global industry major players (Intel, IBM, Apple, Accenture and Oracle) reported healthy revenue growth, indicating
that technology spending is gaining momentum. On the flip side, strong volume growth on the back of slowed
hiring in CY09/ 1HCY10 is leading to a lateral hiring spree. This inturn is leading to supply-side pressure combined
with high attrition across companies. Some companies are resorting to mid-term wage hikes/ promotions/ RSU
awards, etc. While this has affected operating margins, it has also constrained revenue growth for a few companies.
In this backdrop, we expect much higher wage hikes in FY12 than in the past few years. Attrition and its impact on
margins remain key monitorables.
In the dynamic environment, we see Tier1 companies better placed to manage the supply-side challenges with their
scale helping them capitalize on strong demand. Within Tier1, Infosys and TCS are better placed with their
continued fresher hiring programme over the past 2-3 years. TCS is planning 37,000 and Infosys 26,000 campus offers
in the FY12 academic year. With stocks trading at the mean valuations over the business cycle, they are still 15-20%
below their peak level. Infosys and TCS remain core IT holdings. HCL Tech is our preferred pick among large caps,
while in the small/ mid-cap space we like KPIT and Infinite.
Key highlights
Volume growth momentum continues; CY11 IT budgets expected to grow 2-3%
Despite seasonal weakness (Thanksgiving, Diwali and Christmas holidays led to 4-5% lower billing volumes qoq),
Q3FY11 witnessed yet another quarter of volume growth for Indian IT services. The top four IT services companies
registered an average volume growth of 4.3% qoq in Q3FY11 on the back of ~8% growth in the previous two quarters.
In FY12, we expect our thesis of “Accelerated Offshore Adoption” to continue and Indian IT services to witness strong
demand traction led by an improving macroeconomic environment in key global markets. We expect the return of
discretionary spending across major business segments (however, Telecom vertical IT spend has lagged others) and
growth to be largely US-led. Currently, eight of the ten key leading indicators suggest that US economic expansion is
gaining momentum and spreading. Also, the recent QE2 (Quantitative easing 2) from the Federal Reserve has enhanced
the pace of recovery. While Europe continues to face macroeconomic challenges, Indian IT companies so far have not felt
the impact of the same on the IT spending of their clients. In fact, in Q3FY11, revenue growth from Europe was better
than that of the previous quarter, though it still lagged the US.
Global technology major players indicate recovery in tech spending
The recent quarterly results of global technology majors and their management commentary indicate that economic
growth is percolating to tech spending buoyancy. Most of the companies reported record revenue growth and raised
their annual guidance on the back of growing demand. Following are the few data points/ comments from the global
tech industry:
Intel’s fourth quarter saw a third consecutive record quarter and helped the company achieve highest ever annual
revenues of >US$40bn (~24% growth yoy). The company also recorded the highest ever quarterly gross margin,
operating income, and EPS.
IBM reported record fourth quarter revenue of US$29bn (~4% yoy growth) – ahead of Street expectations. The
management expects to see strong revenue growth in FY12.
Apple, a major tech consumer company saw revenues rising by more than 70% yoy to ~US$27bn. iPhone and iPads sales
increased by 75-85%, suggesting an increased demand by consumers.
Accenture reported outsourcing revenue growth of 10% in USD terms and 11% in local currency. Overall, it reported the
second-highest quarterly revenues in its history and exceeded the upper end of its guided range. The company also
raised its FY11 guidance to 8-10% yoy growth from 7-10% earlier.
Oracle reported an outstanding quarter with all – new license revenue, total revenue, and EPS beating guidance. The
company also guided for higher-than-Street expected license revenue growth of 10-20% (9-19% CC) and total revenue
growth of 31-35% (30-34% CC).
Supply-side issues remain a key concern
Companies across the sector reported high attrition rates on a TTM basis, though they commented about a slight easing
in the absolute quarterly attrition. While the way to measure attrition varies from company to company, the trend has
shown an across-the-board increase.
We note that strong volume growth on the back of slower hiring in CY09/ 1H10 has led to a lateral hiring spree. This has
led to supply-side pressure, with attrition remaining high across companies – Tech Mahindra and KPIT witnessed ~30%
quarterly annualized attrition rates. Most companies reported that attrition in the experience band of 3-8 years was the
highest. This experience band is seeing a stark demand-supply mismatch. To keep costs in check, several clients have
been seeking a higher share of mid-level employees, and they neither want a higher proportion of junior inexperienced
resources nor highly experienced delivery employees. This has resulted in higher demand for mid-level employees.
To arrest the high attrition, some companies have been resorting to mid-term wage hikes/ promotions/ RSU awards, etc.
In the recent past, Tech Mahindra (~3% for onsite and senior employees) and Persistent (about ~10% for all offshore
employees, effective Jan’11) announced wage hikes for their employees. In August 2010, Infosys awarded free shares to
its employees, while MphasiS awarded RSUs in November 2010. Wipro also announced promotions and grant of RSUs
in Q2FY11. While these measures have affected operating margins in general, high attrition rates have also constrained
revenue growth for a few companies. Expect much higher wage hikes in FY12 than in the past few years. Though
companies expect attrition rates to decline, we believe attrition rates and their impact on margins remain key
monitorables.
In a supply constrained environment, Infosys and TCS are relatively better placed with their continued fresher hiring
programme over last 2-3 years. For FY12, TCS plans to make 37,000 and Infosys plans 26,000 campus offers.
Diversification beyond ADM and traditional US markets still sluggish
Revenue growth in terms of geography and service line was a mixed bag in Q3FY11. While TCS and Wipro saw strong
growth from Europe; Infosys and HCL Tech saw growth emerging from non-US/ non-European markets. Notably,
Europe and emerging-market growth was aided by cross-currency movements. During the quarter, on a daily average
basis, GBP appreciated by ~2%, Euro by ~5%, Yen by ~4% and AUD by ~9%. In constant currency terms, however,
growth from Europe was a tad below that from the US (except for Wipro). Revenue growth was higher from traditional
application development and maintenance services for Wipro and HCL Tech. However, TCS and Infosys benefited more
from growth in other service lines.
Interestingly, the trend of diversifying revenues to have a higher share of Europe/ AsiaPac and non-ADM services has
still not picked-up. Though Wipro’s share from North America, and TCS and Infosys’s proportion of ADM services are
showing a decreasing trend, all companies still continue to be highly dependent on North America. With the anticipated
return in discretionary spending in FY12, we expect IT companies to start witnessing growth in other service lines as
well.
Earnings upgrade cycle no longer secular
Abating macroeconomic challenges and positive surprises in quarterly results prompted an overall earnings upgrade
cycle for Indian IT services companies. However, now the earnings upgrade cycle is no longer secular. While TCS and
Infosys continue to see earnings upgrade on the back of their robust quarterly performance and margin expansion,
company-specific issues have led to a pause in the upgrade cycle for HCL Tech and Wipro.
Latest quarter (Q3FY11) comparative snapshot for the top four companies
The Q3FY11 results were a mixed bag, with volume growth performances ranging from in-line to better-than-expected.
All four companies did well on the margin front – margins have remained healthy despite pressure from a stronger INR
and supply-side challenges. Demand has clearly picked up, with broad-based volume growth seen across companies
Management commentary and Q4FY11 guidance
The managements of all Tier1 companies commented about an increase in CY11 IT budgets (we expect 2-3% growth)
and a revival of discretionary spending. They suggested that while macroeconomic concerns may linger, they will not
affect the IT services business at large. In its remarks about FY12, the Infosys management commented that it will likely
be a normal year for the industry (+18-20% yoy revenue growth) – similar to FY11. Notably, at the beginning of FY11,
Infosys guided that the year would witness 18-20% yoy revenue growth. However, after continuous upward revisions, it
now expects FY11 revenue growth of ~26%. While the macroeconomic challenges are not completely behind, all IT
services companies expect to witness volume-driven revenue growth in FY12. Pricing is expected to be stable, with a
positive bias.
In general, the fourth fiscal quarter being the first quarter of client’s IT budgets is usually a seasonally weak quarter.
Infosys, usually conservative, guided for 1-2% USD revenue growth (also raised its FY11 USD revenue growth outlook
by ~2% to ~26% yoy), while Wipro, relatively more realistic, guided for 3-5% qoq revenue growth.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
IT services Q3FY11: strong quarter; supply still a concern
The Indian IT services sector is witnessing healthy demand traction, led by an improving macroeconomic
environment. With most of key leading indicators suggesting recovery is under way in the US and economic
expansion is gaining momentum, discretionary IT spend is returning in all major segments. European concerns have
not affected business on the ground, though European revenue growth lags that of the Americas in constant currency
terms. Management commentaries indicate that CY11 IT budgets are expected to grow 2-3%. Despite Q3FY11 being
seasonally weak, all Tier1 companies saw volume growth of ~4% qoq and USD revenue growth of 5.5-7.5% qoq. Even
global industry major players (Intel, IBM, Apple, Accenture and Oracle) reported healthy revenue growth, indicating
that technology spending is gaining momentum. On the flip side, strong volume growth on the back of slowed
hiring in CY09/ 1HCY10 is leading to a lateral hiring spree. This inturn is leading to supply-side pressure combined
with high attrition across companies. Some companies are resorting to mid-term wage hikes/ promotions/ RSU
awards, etc. While this has affected operating margins, it has also constrained revenue growth for a few companies.
In this backdrop, we expect much higher wage hikes in FY12 than in the past few years. Attrition and its impact on
margins remain key monitorables.
In the dynamic environment, we see Tier1 companies better placed to manage the supply-side challenges with their
scale helping them capitalize on strong demand. Within Tier1, Infosys and TCS are better placed with their
continued fresher hiring programme over the past 2-3 years. TCS is planning 37,000 and Infosys 26,000 campus offers
in the FY12 academic year. With stocks trading at the mean valuations over the business cycle, they are still 15-20%
below their peak level. Infosys and TCS remain core IT holdings. HCL Tech is our preferred pick among large caps,
while in the small/ mid-cap space we like KPIT and Infinite.
Key highlights
Volume growth momentum continues; CY11 IT budgets expected to grow 2-3%
Despite seasonal weakness (Thanksgiving, Diwali and Christmas holidays led to 4-5% lower billing volumes qoq),
Q3FY11 witnessed yet another quarter of volume growth for Indian IT services. The top four IT services companies
registered an average volume growth of 4.3% qoq in Q3FY11 on the back of ~8% growth in the previous two quarters.
In FY12, we expect our thesis of “Accelerated Offshore Adoption” to continue and Indian IT services to witness strong
demand traction led by an improving macroeconomic environment in key global markets. We expect the return of
discretionary spending across major business segments (however, Telecom vertical IT spend has lagged others) and
growth to be largely US-led. Currently, eight of the ten key leading indicators suggest that US economic expansion is
gaining momentum and spreading. Also, the recent QE2 (Quantitative easing 2) from the Federal Reserve has enhanced
the pace of recovery. While Europe continues to face macroeconomic challenges, Indian IT companies so far have not felt
the impact of the same on the IT spending of their clients. In fact, in Q3FY11, revenue growth from Europe was better
than that of the previous quarter, though it still lagged the US.
Global technology major players indicate recovery in tech spending
The recent quarterly results of global technology majors and their management commentary indicate that economic
growth is percolating to tech spending buoyancy. Most of the companies reported record revenue growth and raised
their annual guidance on the back of growing demand. Following are the few data points/ comments from the global
tech industry:
Intel’s fourth quarter saw a third consecutive record quarter and helped the company achieve highest ever annual
revenues of >US$40bn (~24% growth yoy). The company also recorded the highest ever quarterly gross margin,
operating income, and EPS.
IBM reported record fourth quarter revenue of US$29bn (~4% yoy growth) – ahead of Street expectations. The
management expects to see strong revenue growth in FY12.
Apple, a major tech consumer company saw revenues rising by more than 70% yoy to ~US$27bn. iPhone and iPads sales
increased by 75-85%, suggesting an increased demand by consumers.
Accenture reported outsourcing revenue growth of 10% in USD terms and 11% in local currency. Overall, it reported the
second-highest quarterly revenues in its history and exceeded the upper end of its guided range. The company also
raised its FY11 guidance to 8-10% yoy growth from 7-10% earlier.
Oracle reported an outstanding quarter with all – new license revenue, total revenue, and EPS beating guidance. The
company also guided for higher-than-Street expected license revenue growth of 10-20% (9-19% CC) and total revenue
growth of 31-35% (30-34% CC).
Supply-side issues remain a key concern
Companies across the sector reported high attrition rates on a TTM basis, though they commented about a slight easing
in the absolute quarterly attrition. While the way to measure attrition varies from company to company, the trend has
shown an across-the-board increase.
We note that strong volume growth on the back of slower hiring in CY09/ 1H10 has led to a lateral hiring spree. This has
led to supply-side pressure, with attrition remaining high across companies – Tech Mahindra and KPIT witnessed ~30%
quarterly annualized attrition rates. Most companies reported that attrition in the experience band of 3-8 years was the
highest. This experience band is seeing a stark demand-supply mismatch. To keep costs in check, several clients have
been seeking a higher share of mid-level employees, and they neither want a higher proportion of junior inexperienced
resources nor highly experienced delivery employees. This has resulted in higher demand for mid-level employees.
To arrest the high attrition, some companies have been resorting to mid-term wage hikes/ promotions/ RSU awards, etc.
In the recent past, Tech Mahindra (~3% for onsite and senior employees) and Persistent (about ~10% for all offshore
employees, effective Jan’11) announced wage hikes for their employees. In August 2010, Infosys awarded free shares to
its employees, while MphasiS awarded RSUs in November 2010. Wipro also announced promotions and grant of RSUs
in Q2FY11. While these measures have affected operating margins in general, high attrition rates have also constrained
revenue growth for a few companies. Expect much higher wage hikes in FY12 than in the past few years. Though
companies expect attrition rates to decline, we believe attrition rates and their impact on margins remain key
monitorables.
In a supply constrained environment, Infosys and TCS are relatively better placed with their continued fresher hiring
programme over last 2-3 years. For FY12, TCS plans to make 37,000 and Infosys plans 26,000 campus offers.
Diversification beyond ADM and traditional US markets still sluggish
Revenue growth in terms of geography and service line was a mixed bag in Q3FY11. While TCS and Wipro saw strong
growth from Europe; Infosys and HCL Tech saw growth emerging from non-US/ non-European markets. Notably,
Europe and emerging-market growth was aided by cross-currency movements. During the quarter, on a daily average
basis, GBP appreciated by ~2%, Euro by ~5%, Yen by ~4% and AUD by ~9%. In constant currency terms, however,
growth from Europe was a tad below that from the US (except for Wipro). Revenue growth was higher from traditional
application development and maintenance services for Wipro and HCL Tech. However, TCS and Infosys benefited more
from growth in other service lines.
Interestingly, the trend of diversifying revenues to have a higher share of Europe/ AsiaPac and non-ADM services has
still not picked-up. Though Wipro’s share from North America, and TCS and Infosys’s proportion of ADM services are
showing a decreasing trend, all companies still continue to be highly dependent on North America. With the anticipated
return in discretionary spending in FY12, we expect IT companies to start witnessing growth in other service lines as
well.
Earnings upgrade cycle no longer secular
Abating macroeconomic challenges and positive surprises in quarterly results prompted an overall earnings upgrade
cycle for Indian IT services companies. However, now the earnings upgrade cycle is no longer secular. While TCS and
Infosys continue to see earnings upgrade on the back of their robust quarterly performance and margin expansion,
company-specific issues have led to a pause in the upgrade cycle for HCL Tech and Wipro.
Latest quarter (Q3FY11) comparative snapshot for the top four companies
The Q3FY11 results were a mixed bag, with volume growth performances ranging from in-line to better-than-expected.
All four companies did well on the margin front – margins have remained healthy despite pressure from a stronger INR
and supply-side challenges. Demand has clearly picked up, with broad-based volume growth seen across companies
Management commentary and Q4FY11 guidance
The managements of all Tier1 companies commented about an increase in CY11 IT budgets (we expect 2-3% growth)
and a revival of discretionary spending. They suggested that while macroeconomic concerns may linger, they will not
affect the IT services business at large. In its remarks about FY12, the Infosys management commented that it will likely
be a normal year for the industry (+18-20% yoy revenue growth) – similar to FY11. Notably, at the beginning of FY11,
Infosys guided that the year would witness 18-20% yoy revenue growth. However, after continuous upward revisions, it
now expects FY11 revenue growth of ~26%. While the macroeconomic challenges are not completely behind, all IT
services companies expect to witness volume-driven revenue growth in FY12. Pricing is expected to be stable, with a
positive bias.
In general, the fourth fiscal quarter being the first quarter of client’s IT budgets is usually a seasonally weak quarter.
Infosys, usually conservative, guided for 1-2% USD revenue growth (also raised its FY11 USD revenue growth outlook
by ~2% to ~26% yoy), while Wipro, relatively more realistic, guided for 3-5% qoq revenue growth.
No comments:
Post a Comment