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Cognizant guidance will be the driver
CNXIT has outperformed Nifty by 12 pp over 6 and 12 months
on the back of strong earnings upgrades for TCS (14% and
19% for FY11 and FY12 respectively over the last 12 months),
improving 2011 US economic growth expectations (from 2.5%
real GDP growth in Oct 2010 to 3.1% in March 2011) and flight
to quality and non-interest rate sensitive sectors in the Indian
market over the last 6 months. We do not expect JFM quarter
results of IT services companies listed in India or the Infy
guidance (if it is along consensus expectations of 16-20%) to
provide direction to FY12 consensus estimates. We believe
Cognizant’s revision of guidance is a more critical data point.
We believe the strong growth priced in by sell side (24%
revenue and 22% profit growth for Infosys + TCS for FY12E)
implies a material upward revision of guidance by Cognizant
(which has already guided for 26% growth in 2011) as there
has been at least a 15 percentage point difference in growth
between the Indian Tier-1 players and Cognizant over the last
5 years. If the upward revision does not come through we
believe the IT services sector performance will likely stagnate
for the next 2-3 months.
Our estimates for FY12 and FY13 are below consensus as we
believe strong growth seen in FY11 is partly to do with pent
up demand and believe there will be normalisation in FY12
and that margins would be under greater pressure than
consensus estimates as (a) price increase (for like-to-like
services) will likely be muted due to significant competitive
intensity amongst Indian providers as well as with MNC
players striving to hold on to their existing contracts (b) salary
increases will be only marginally less than that given in FY11
(c) employee pyramid benefits are unlikely to be material with
consulting/package implementation type of work gaining
ground in FY12, when hiring will continue to remain skewed
towards laterals (d) likely higher number of local employees
as visa related issues mount which might effectively push up
costs (e) margin levers have been largely exhausted for most
players.
The upside risk to our more cautious than consensus view on
the sector will likely come from (1) stronger than expected
nominal US GDP and S&P 500 sales growth data leading to
better volume growth (2) strong growth in product as well as
IP related sales that could improve realisations much more
than currently expected, offsetting cost pressures.
Things to look out for in the JFM Results
A mixed quarter likely: Volume growth (QoQ) should likely be in the 3-5% range for the Tier-1
Indian players with flat pricing. There is likely to be some cross currency benefits from the
USD/Euro side that could partly offset the rupee appreciation. Attrition and likely wage hikes in
FY12, commentary on pricing, hiring, etc in our view would be points to be watched during the
conference calls. After a series of one-offs in FY11, FY12 could potentially pan out as a “normal”
year. Effects of pent up demand tailing off, lack of M&A related restructuring and austerity
measures could be felt which could likely subdue the euphoria of demand pick up seen earlier
in the sector. We believe the regulatory and compliance related demand would likely pan out
far more slowly in the BFS space than has the M&A related integration work.
The Infosys guidance: We expect 16-18% (in line with the NASSCOM projection for the
industry) growth guidance along with a likely EPS of Rs136-138 (12-14% growth based on our
EPS estimates for FY11 – Rs121.7) for the company.
Change in Management at Infosys and risk taking appetite going forward: Media has been
speculating about likely change in the management structure at Infosys and the possibility of
that happening in April itself. We attach a high probability to such an event as we believe NRN
would like that to happen a few months before he steps down as Chairman in August 2011.
Going beyond this change one needs to see if the company begins to take bigger risks in terms
of acquisitions – in terms of size or valuations, be willing to explore more models which may be
slightly margin dilutive or capital intensive.
Pricing commentary critical: Despite strong and better than expected volume growth, pricing
has not improved despite commentary from some companies in the early part of FY11. While
there has been a mix driven realisation increase we believe improved pricing for like-for-like
services is critical to maintain margins in the days ahead considering supply side pressures.
There has been realisation increase in OND 2010 for many companies both large and small on
the back of higher IP related sales, likely Fixed Price related bonuses, and a better revenue mix
largely driven by faster growth of consulting and package implementation related business. We
believe that realisations will likely normalise in JFM and there could be downward bias QoQ
Salary hikes need to be watched: While FY11 was a year of large compensation hikes by
companies (fixed, variable, promotions, RSUs, etc) to retain employees the increasing tilt
towards hiring laterals in our view would lead to continuing pressure in FY12 too. Hiring plans
going into FY12 and the mix would give a clue of the likely salary pressures in FY12. We expect
the situation to be only marginally better than that of FY11. We believe mid-caps will continue
to see higher pressure on their compensation structure compared to the large caps.
Watch market share gain by MNCs: In our sector initiation piece ‘Focus on the Macro and not
the micro’, Oct 2010, we had indicated that the convergence of business models between the
global incumbents and the offshore upstarts is likely a bit skewed with the global MNCs having
been able to build out offshore back ends far faster than Indian players have been able to build
their consulting front ends. This we believe will hurt Indian players’ growth in the future as the
value proposition is likely to be equal or more compelling for the global incumbents’ vis-à-vis
existing/potential customers with in the offshore space. So one really cannot extrapolate the
strong result of say an Accenture as an indicator of likely demand for the Industry.
TCS (Rating – Sell; Target Price – Rs855)
We expect TCS to report a volume growth of 5% in Q4 with flat realizations. Appreciation in
rupee will be negated with favorable cross currency movements.
We expect EBITDA margin to improve marginally by 10bps to 30.2%. PAT margin will however
likely decline by 70bps versus last quarter as PAT was boosted by Rs521mn of net foreign
exchange gain last quarter.
Commentary on demand environment and outlook for FY12 will be the key things to watch out
for. TCS has been the most bullish on the street indicating that FY12 would be better than FY11
in terms of revenue growth. A reiteration of this statement would be seen as positive. On the
other hand any dilution of this statement going forward would be seen as one indicator of
demand weakness.
We are expecting attrition levels to stabilize. Wage pressure and attrition levels will however be
closely watched.
Infosys (Rating – Hold; Target Price – Rs3,340)
We expect revenue growth of 5.6% on a sequential basis driven by 5% volume growth.
Currency impact is expected to be neutral as cross currency tail winds largely will take care of
rupee appreciation.
We expect EBITDA margin to improve by 70bps driven by volume growth. PAT is expected to
grow at 9.6% due to lower tax rate. Tax rate we have factored is 26% versus 27% last quarter.
We are expecting operating margin to improve by ~90bps largely because of the top line
growth.
Wipro (Rating – Sell; Target Price – Rs348)
We expect Wipro to lag its larger peers again with a volume growth of 3%. Pricing will remain
stable while currency impact will be neutral.
Commentary regarding TK Kurien’s growth strategy and focus areas will be important.
Would watch out for attrition at the middle and senior management layers considering the
management change and internal restructuring that has just occurred.
Cognizant (Rating – Hold; Target Price – Rs76)
We expect Cognizant to post a volume growth of 7% leading to a sequential revenue growth of
6.8%. Pricing is expected to be stable.
Operating margin (EBIT) is expected to decline marginally by 40bps due to higher SG&A
expense while PAT margin will remain flat at 15.6% as higher other income (due to higher cash
at the end of Q4CY10) will compensate for lower operating margin.
2011 growth outlook will hold the key. A material increase (4-5% plus) will be positive for the
stock and would have a positive rub off effect on its India listed peers.
HCL Technologies (Rating – Hold; Target Price – Rs490)
We expect a sequential volume growth of 5% for Q3FY11 while no pricing growth for Software
services. Overall revenue is expected to grow by 5% sequentially.
We expect BPO to post operating (EBIT) loss of Rs240mn.
EBITDA margin is expected to expand by ~170bps due to lower SG&A and lower BPO losses.
PAT will be further boosted by the absence of forex loss in this quarter. We are expecting a PAT
growth of 21.7% to Rs4,864mn.
Mphasis (Rating – Under Review; Target Price – Under Review)
We are expecting a 7.4% sequential revenue growth in Q2FY11 driven by volume growth of 7%.
High volume growth is on back of base effect (negative 5% volume growth in the previous
quarter).
We expect PAT of Rs2,307mn, a sequential growth of 1.8% only due to higher tax rate of 15%
versus a tax rate of 11.5% in the previous quarter.
Commentary on pricing discounts and rate cuts for HP’s customers will hold the key. Growth of
direct sales channel vis-à-vis HP channel will be another important trend one should look at.
Patni (Rating – Not Rated; Target Price – Not Rated)
We are expecting a muted volume growth of 1% for Patni. Pricing environment will be stable.
We expect PAT to decline by 25.6% on a sequential basis due to higher taxes. We expect tax rate
to be 18% in this quarter as against tax credit of 2% in the previous quarter.
Update on iGate’s plans of merging the two entities or de-listing Patni will be important. Status
of open offer by iGate will also hold the key for Patni’s investors.
One should also watch out for the impact of this acquisition on new deal wins for Patni if any
and employee attrition.
Mindtree (Rating – Buy; Target Price – Rs506)
We are expecting a volume growth of 2% as the loss of $1.5mn revenue from one of Kyocera’s
client will have an impact on the top line.
EBITDA margin is likely to expand by ~600 bps because of the absence of restructuring cost and
investment in NIW business in this quarter.
PAT margin will expand by 360bps as higher tax rate in Q4 will erode some of the EBITDA
margin gains. Effective tax rate for Q4 is expected to be 15% as against 10% in Q3. Tax benefit
due to restructuring of loss making NIW business led to lower tax rate in the previous quarter.
Hexaware (Rating – Sell; Target Price – Rs50)
We expect Hexaware to report top line of $70mn, a sequential growth of 5% largely driven by
volume growth.
EBITDA margin is likely to expand by ~120bps due to lower SG&A expenses.
Deal flows and Commentary on client’s discretionary budget will be important things to look
out for during the conference call.
Persistent Systems (Rating – Sell; Target Price – Rs366)
We expect volume growth of 5% as acquisition of Infospectrum will add close to $1mn to the
top line in Q4. Full impact of this acquisition will be realized from Q1FY12.
We expect EBITDA to decline by 110bps because of the salary increase given last quarter.
Likely higher tax rate of 9% versus 8% last quarter will result in PAT growth of only 1.2%
sequentially.
We do not expect any material improvement in the demand environment for the OPD space.
Management’s commentary regarding the same and guidance for FY12 will be key things to
watch out for.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Cognizant guidance will be the driver
CNXIT has outperformed Nifty by 12 pp over 6 and 12 months
on the back of strong earnings upgrades for TCS (14% and
19% for FY11 and FY12 respectively over the last 12 months),
improving 2011 US economic growth expectations (from 2.5%
real GDP growth in Oct 2010 to 3.1% in March 2011) and flight
to quality and non-interest rate sensitive sectors in the Indian
market over the last 6 months. We do not expect JFM quarter
results of IT services companies listed in India or the Infy
guidance (if it is along consensus expectations of 16-20%) to
provide direction to FY12 consensus estimates. We believe
Cognizant’s revision of guidance is a more critical data point.
We believe the strong growth priced in by sell side (24%
revenue and 22% profit growth for Infosys + TCS for FY12E)
implies a material upward revision of guidance by Cognizant
(which has already guided for 26% growth in 2011) as there
has been at least a 15 percentage point difference in growth
between the Indian Tier-1 players and Cognizant over the last
5 years. If the upward revision does not come through we
believe the IT services sector performance will likely stagnate
for the next 2-3 months.
Our estimates for FY12 and FY13 are below consensus as we
believe strong growth seen in FY11 is partly to do with pent
up demand and believe there will be normalisation in FY12
and that margins would be under greater pressure than
consensus estimates as (a) price increase (for like-to-like
services) will likely be muted due to significant competitive
intensity amongst Indian providers as well as with MNC
players striving to hold on to their existing contracts (b) salary
increases will be only marginally less than that given in FY11
(c) employee pyramid benefits are unlikely to be material with
consulting/package implementation type of work gaining
ground in FY12, when hiring will continue to remain skewed
towards laterals (d) likely higher number of local employees
as visa related issues mount which might effectively push up
costs (e) margin levers have been largely exhausted for most
players.
The upside risk to our more cautious than consensus view on
the sector will likely come from (1) stronger than expected
nominal US GDP and S&P 500 sales growth data leading to
better volume growth (2) strong growth in product as well as
IP related sales that could improve realisations much more
than currently expected, offsetting cost pressures.
Things to look out for in the JFM Results
A mixed quarter likely: Volume growth (QoQ) should likely be in the 3-5% range for the Tier-1
Indian players with flat pricing. There is likely to be some cross currency benefits from the
USD/Euro side that could partly offset the rupee appreciation. Attrition and likely wage hikes in
FY12, commentary on pricing, hiring, etc in our view would be points to be watched during the
conference calls. After a series of one-offs in FY11, FY12 could potentially pan out as a “normal”
year. Effects of pent up demand tailing off, lack of M&A related restructuring and austerity
measures could be felt which could likely subdue the euphoria of demand pick up seen earlier
in the sector. We believe the regulatory and compliance related demand would likely pan out
far more slowly in the BFS space than has the M&A related integration work.
The Infosys guidance: We expect 16-18% (in line with the NASSCOM projection for the
industry) growth guidance along with a likely EPS of Rs136-138 (12-14% growth based on our
EPS estimates for FY11 – Rs121.7) for the company.
Change in Management at Infosys and risk taking appetite going forward: Media has been
speculating about likely change in the management structure at Infosys and the possibility of
that happening in April itself. We attach a high probability to such an event as we believe NRN
would like that to happen a few months before he steps down as Chairman in August 2011.
Going beyond this change one needs to see if the company begins to take bigger risks in terms
of acquisitions – in terms of size or valuations, be willing to explore more models which may be
slightly margin dilutive or capital intensive.
Pricing commentary critical: Despite strong and better than expected volume growth, pricing
has not improved despite commentary from some companies in the early part of FY11. While
there has been a mix driven realisation increase we believe improved pricing for like-for-like
services is critical to maintain margins in the days ahead considering supply side pressures.
There has been realisation increase in OND 2010 for many companies both large and small on
the back of higher IP related sales, likely Fixed Price related bonuses, and a better revenue mix
largely driven by faster growth of consulting and package implementation related business. We
believe that realisations will likely normalise in JFM and there could be downward bias QoQ
Salary hikes need to be watched: While FY11 was a year of large compensation hikes by
companies (fixed, variable, promotions, RSUs, etc) to retain employees the increasing tilt
towards hiring laterals in our view would lead to continuing pressure in FY12 too. Hiring plans
going into FY12 and the mix would give a clue of the likely salary pressures in FY12. We expect
the situation to be only marginally better than that of FY11. We believe mid-caps will continue
to see higher pressure on their compensation structure compared to the large caps.
Watch market share gain by MNCs: In our sector initiation piece ‘Focus on the Macro and not
the micro’, Oct 2010, we had indicated that the convergence of business models between the
global incumbents and the offshore upstarts is likely a bit skewed with the global MNCs having
been able to build out offshore back ends far faster than Indian players have been able to build
their consulting front ends. This we believe will hurt Indian players’ growth in the future as the
value proposition is likely to be equal or more compelling for the global incumbents’ vis-à-vis
existing/potential customers with in the offshore space. So one really cannot extrapolate the
strong result of say an Accenture as an indicator of likely demand for the Industry.
TCS (Rating – Sell; Target Price – Rs855)
We expect TCS to report a volume growth of 5% in Q4 with flat realizations. Appreciation in
rupee will be negated with favorable cross currency movements.
We expect EBITDA margin to improve marginally by 10bps to 30.2%. PAT margin will however
likely decline by 70bps versus last quarter as PAT was boosted by Rs521mn of net foreign
exchange gain last quarter.
Commentary on demand environment and outlook for FY12 will be the key things to watch out
for. TCS has been the most bullish on the street indicating that FY12 would be better than FY11
in terms of revenue growth. A reiteration of this statement would be seen as positive. On the
other hand any dilution of this statement going forward would be seen as one indicator of
demand weakness.
We are expecting attrition levels to stabilize. Wage pressure and attrition levels will however be
closely watched.
Infosys (Rating – Hold; Target Price – Rs3,340)
We expect revenue growth of 5.6% on a sequential basis driven by 5% volume growth.
Currency impact is expected to be neutral as cross currency tail winds largely will take care of
rupee appreciation.
We expect EBITDA margin to improve by 70bps driven by volume growth. PAT is expected to
grow at 9.6% due to lower tax rate. Tax rate we have factored is 26% versus 27% last quarter.
We are expecting operating margin to improve by ~90bps largely because of the top line
growth.
Wipro (Rating – Sell; Target Price – Rs348)
We expect Wipro to lag its larger peers again with a volume growth of 3%. Pricing will remain
stable while currency impact will be neutral.
Commentary regarding TK Kurien’s growth strategy and focus areas will be important.
Would watch out for attrition at the middle and senior management layers considering the
management change and internal restructuring that has just occurred.
Cognizant (Rating – Hold; Target Price – Rs76)
We expect Cognizant to post a volume growth of 7% leading to a sequential revenue growth of
6.8%. Pricing is expected to be stable.
Operating margin (EBIT) is expected to decline marginally by 40bps due to higher SG&A
expense while PAT margin will remain flat at 15.6% as higher other income (due to higher cash
at the end of Q4CY10) will compensate for lower operating margin.
2011 growth outlook will hold the key. A material increase (4-5% plus) will be positive for the
stock and would have a positive rub off effect on its India listed peers.
HCL Technologies (Rating – Hold; Target Price – Rs490)
We expect a sequential volume growth of 5% for Q3FY11 while no pricing growth for Software
services. Overall revenue is expected to grow by 5% sequentially.
We expect BPO to post operating (EBIT) loss of Rs240mn.
EBITDA margin is expected to expand by ~170bps due to lower SG&A and lower BPO losses.
PAT will be further boosted by the absence of forex loss in this quarter. We are expecting a PAT
growth of 21.7% to Rs4,864mn.
Mphasis (Rating – Under Review; Target Price – Under Review)
We are expecting a 7.4% sequential revenue growth in Q2FY11 driven by volume growth of 7%.
High volume growth is on back of base effect (negative 5% volume growth in the previous
quarter).
We expect PAT of Rs2,307mn, a sequential growth of 1.8% only due to higher tax rate of 15%
versus a tax rate of 11.5% in the previous quarter.
Commentary on pricing discounts and rate cuts for HP’s customers will hold the key. Growth of
direct sales channel vis-à-vis HP channel will be another important trend one should look at.
Patni (Rating – Not Rated; Target Price – Not Rated)
We are expecting a muted volume growth of 1% for Patni. Pricing environment will be stable.
We expect PAT to decline by 25.6% on a sequential basis due to higher taxes. We expect tax rate
to be 18% in this quarter as against tax credit of 2% in the previous quarter.
Update on iGate’s plans of merging the two entities or de-listing Patni will be important. Status
of open offer by iGate will also hold the key for Patni’s investors.
One should also watch out for the impact of this acquisition on new deal wins for Patni if any
and employee attrition.
Mindtree (Rating – Buy; Target Price – Rs506)
We are expecting a volume growth of 2% as the loss of $1.5mn revenue from one of Kyocera’s
client will have an impact on the top line.
EBITDA margin is likely to expand by ~600 bps because of the absence of restructuring cost and
investment in NIW business in this quarter.
PAT margin will expand by 360bps as higher tax rate in Q4 will erode some of the EBITDA
margin gains. Effective tax rate for Q4 is expected to be 15% as against 10% in Q3. Tax benefit
due to restructuring of loss making NIW business led to lower tax rate in the previous quarter.
Hexaware (Rating – Sell; Target Price – Rs50)
We expect Hexaware to report top line of $70mn, a sequential growth of 5% largely driven by
volume growth.
EBITDA margin is likely to expand by ~120bps due to lower SG&A expenses.
Deal flows and Commentary on client’s discretionary budget will be important things to look
out for during the conference call.
Persistent Systems (Rating – Sell; Target Price – Rs366)
We expect volume growth of 5% as acquisition of Infospectrum will add close to $1mn to the
top line in Q4. Full impact of this acquisition will be realized from Q1FY12.
We expect EBITDA to decline by 110bps because of the salary increase given last quarter.
Likely higher tax rate of 9% versus 8% last quarter will result in PAT growth of only 1.2%
sequentially.
We do not expect any material improvement in the demand environment for the OPD space.
Management’s commentary regarding the same and guidance for FY12 will be key things to
watch out for.
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