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1Q FY12F results preview
1Q results a window to FY12 and a test of nervous expectations
1Q FY12F: evenue growth of 2-8%, margins to see wage hike impact
We believe investors will look for the following in the 1Q FY12F results: 1)
the impact of macroeconomic deterioration on demand and the outlook for
Indian IT companies; 2) shifting of client spending priorities toward
discretionary spending; 3) continuation of positive pricing momentum; and
4) the impact of an increase in visa rejections on revenue growth and
margins. We expect revenue growth of 2-8% q-q across tier-1 Indian IT
companies (including Cognizant), with Cognizant leading, followed by TCS
and Wipro lagging on growth. Margins across companies are likely to be
impacted by wage inflation, with the exception of HCL Tech. We expect
only a marginal increase in Infosys’ and Cognizant’s guidance for FY12.
Action: Infosys and HCL Tech most preferred, Wipro least preferred
Our stock preferences are driven by our sector stance on preferring
companies which require: 1) lower volume growth to meet growth
expectations (Infosys); 2) greater skew towards discretionary demand
(Infosys, HCL Tech); and 3) market-share-gain-focused companies (HCL
Tech and Cognizant). Our top BUYs in the sector remain Infosys followed
by HCL Tech. We think Cognizant’s future performance may disappoint,
while at TCS valuations leave limited room for upside. Wipro is our least
preferred stock, as results of its restructuring may take time to fructify. We
maintain REDUCE on Mphasis and NEUTRAL on Tech Mahindra.
Catalysts: Guidance upgrades and pricing power a positive
Upgrades in revenue growth guidance at Infosys and Cognizant and
continuation of pricing power momentum could be positive triggers for
stocks. In-line revenues and guidance at Infosys would be taken positively,
in our view, while in-line results at TCS might not provide enough
ammunition to sustain the stock price
1Q FY12F preview – window to FY12
Impact of macro headwinds and discretionary demand
traction needs to be watched
We believe investors will look for the following cues from the 1Q FY12F results of the
Indian IT sector: 1) the impact of macroeconomic deterioration on the demand and
outlook of Indian IT companies; 2) shifting of client spending priorities toward
discretionary spending; 3) continuation of the positive pricing momentum; and 4) the
impact of an increase in the number of visa rejections on revenue growth and margins.
We expect revenue growth of 2-8% q-q across tier-1 Indian IT companies (including
Cognizant), with Cognizant leading, followed by TCS and Wipro lagging on growth.
Margins across companies are likely to be impacted by wage inflation, with the exception
of HCL Tech, where the salary impact comes a quarter ahead.
Cognizant and TCS to lead, Wipro to lag on growth
We expect Cognizant (8% q-q) and TCS (6% q-q) to lead on revenue growth, while
Wipro is likely to lag (2.1% q-q including contribution from SAIC unit acquisition). Infosys
and HCL Tech should be comparable on growth of 4.2-4.6% q-q. On margins, Infosys
should be the worst hit at 250bps, followed by TCS (180bps), Wipro (130bps) and
Cognizant (70bp), in that order. We expect HCL Tech to show a 140bp improvement in
EBITDA margin, in line with guidance. We believe there could be downside surprises to
our Cognizant revenue growth estimates on continuing company-specific weakness in
Europe
Marginal increase in revenue and earnings guidance likely
We expect the FY12 revenue guidance of Infosys and Cognizant to be raised only
marginally by ~100bps to 21% and 30% at the top end, citing macro uncertainty and inline performance. Earnings guidance at Infosys might be raised to INR130 per share (vs
INR128 earlier) at the higher end, we believe. We expect Infosys will guide for ~6% q-q
growth in 2Q FY12F. Upside surprises to our guidance expectation could be positive for
the stocks.
Catalysts
Upgrades in revenue growth guidance at Infosys and Cognizant and continuation of
pricing power momentum could be positive triggers for stocks, in our view. Revenues
and guidance coming in line with our expectations at Infosys would be taken positively, in
our opinion, while in-line results at TCS might not provide enough ammunition for further
stock price appreciation.
Sector view: selectively positive
We have not been in the camp arguing for exuberant revenue growth touching 30%
levels for the tier-1 Indian IT players in FY12. We have maintained that growth would be
healthy, in the 20-25% range for the tier-1 players. Also, our expectations on margin
declines over the period FY11-13F continue to be more pessimistic compared with street
expectations. This is given our belief that supply-side pressures and growth investments
that are required to push growth would pressure margins.
These fears came true in the 4Q FY11 results, when the volume growth across
companies disappointed Street expectations, with pricing being the saving grace in terms
of keeping results in line. This has led to a reset of street expectations in terms of growth
and margins.
We are selectively positive on the sector, with the demand outlook remaining robust
despite macro concerns, given:
• Tech unemployment rate improvement in the US provides greater comfort on demand,
despite macro headwinds.
• Shifting of client spending priorities toward discretionary/front-end facing and
transformational work has been highlighted by recent results at Oracle, SAP and
Accenture, which augur well for companies like Infosys and HCL Tech, in our view.
• Visa and protectionism issues are a nuisance, in our view, leading to procedural delays
and some-fine tuning in terms of staffing — but not necessarily a disruption to the
business of Indian IT players. We do not anticipate major revenue or margin pressures
on account of the elevation in visa rejection rates.
In light of the macro concerns on demand, we suggest backing stocks which require less
volume requirement to meet growth expectations, those that normally gain on
discretionary demand trends, and we prefer market-gain-focused companies, which
typically do well even in slack economic environments. This, coupled with reasonable
valuations, remains the basis for our stock preferences.
Prefer Infosys, HCL Tech; Wipro least preferred
Our top BUYs in the sector remain Infosys followed by HCL Tech. Among our NEUTRAL
ratings, we prefer Cognizant over TCS and Wipro. Our stock preferences are driven by
our sector stance on preferring companies which require:
• Lower volume growth to meet growth expectations (Infosys needs only 17% volume
growth to meet our FY12F revenue growth expectations compared with 24.3% at TCS,
on our estimates). We expect USD revenue growth of 24.3% at Infosys and 25.5% at
TCS in FY12F.
• Greater skew towards discretionary demand (Infosys, HCL Tech), with 22-30% of
revenues coming from discretionary service lines like package implementation and
products,
• Market-share-gain-focused companies (HCL Tech and Cognizant) with higher SGA
spending and lower margin expectations.
We would likely re-evaluate our view on Cognizant on a 5-10% share price correction
from current levels, while at TCS we believe valuations leave limited room for upside.
Wipro is our least preferred stock among tier-1 IT companies as the recent restructuring
could take time to bear fruit, in our view, while also having an impact on revenue growth
and margins in the near term. We maintain REDUCE on Mphasis and NEUTRAL on
Tech Mahindra
What will take stock prices higher?
Infosys: Revenue growth in line with expectations (4.6% q-q) and revenue growth
guidance stronger than 6% q-q for 2Q FY12F would likely be taken positively by the
street, as that would imply a lower hurdle for 2H FY12F for growth expectations to be
met, in our view. This would also provide greater certainty to our belief that: 1) the
restructuring at Infosys is not materially disruptive; and 2) there are no fundamental
issues with demand at Infosys. Continuation of the positive pricing momentum seen in
FY11 (5% constant currency terms pricing increase over the last three quarters) could
push the guidance higher.
HCL Tech: Near-term stock price upside might be capped by flattish commentary on
FY12F margins, despite expected achievement of stated margin improvement in 4Q
FY11F. We believe reinforcement of the strong volume growth trajectory at HCL Tech
would be essential for the stock’s next move up. Longer term, we maintain a positive
view on the stock given revenue momentum. We are not perturbed by management’s
intention of keeping margins flattish as long as the company continues to beat its peers
on revenue and EPS growth.
Cognizant: Cognizant’s return to outperformance over tier-1 Indian IT players on
sequential revenue growth could be a positive trigger. The company has not materially
outperformed tier-1 Indian IT peers on revenue growth over the past three quarters. A
return to revenue growth outperformance could strengthen the case for premium
valuations in our view, given a predictable margin trajectory. Revenue growth guidance
in excess of 31% over FY12F (vs current guidance of 29%) would be a positive stock
trigger, as this would build in acceleration in revenue growth compared with previous
street expectations, in our view.
TCS: Without significantly beating our 6% q-q expectation for 1Q FY12 revenue growth
and visibility of material pricing momentum (an area where pricing commentary of
management has turned more sober over the past three quarters), we believe the stock
might start to underperform on already high street expectations. Our FY12-13F earnings
estimates are lower than Bloomberg consensus expectations by 3-5%.
Wipro: Early signs of a revival in revenue growth post restructuring would be a keenly
watched metric. We believe this is unlikely to materialize in 1Q FY12, and investors
might need to wait for longer for this to be visible. We think the stock carries the risk of
consensus downgrades if revenue growth guidance for 2QFY12F is lower than 5% q-q
(organic growth). Our FY12-13F earnings estimates for Wipro are some 5% lower than
Bloomberg consensus.
Pertinent trends that could shape stock performance in FY12
We highlight four key potential trends that we think are likely to shape stock performance
in FY12-13:
• Sharp decline in US Tech unemployment and countercyclical moves to US
unemployment, providing comfort to the strong IT services demand argument. This is
despite macro deterioration concerns.
• Shift in client spending priorities toward discretionary segments, especially in the US
and emerging markets, indicating to us a shift from a pure cost take-out focus
previously.
• Significant YTD outperformance of MNC stocks, like Accenture, IBM and Cap Gemini
vs Indian IT players, could lead to a shift in investor preferences toward more
reasonably valued Indian IT stocks.
• Price increases in FY11 have been a positive surprise; continuation of this trend in
FY12 could be a positive trigger for the stocks.
Sharp decline in US tech unemployment rate provides
demand comfort, despite macro deterioration
As we see it, divergence in tech unemployment and overall unemployment trends in the
US indicate the clouds on the horizon are not as menacing as made out to be by macro
economic deterioration fears in the US and Europe (key markets for Indian IT). The trend
below clearly indicates that the tech industry continues to do better at job creation
compared to overall US economy. Secondly, periods of low tech unemployment or falling
tech unemployment are typically better in terms of growth for the Indian IT industry. This
has been reflected in the superior industry growth rate in period FY06-08 and then again
in FY11. With tech unemployment falling from a peak of 6.5% in Mar-10 to 3.8% in May-
11, and the tech industry approaching the seasonally stronger tech demand periods, we
believe strong revenue momentum should be sustained for the industry, despite a largely
jobless recovery in the US.
Shift in client spending priorities toward discretionary
demand
We believe a key trend that would shape demand going into FY12F is a shift in spending
priorities toward discretionary demand areas like package implementation and
consulting, especially in the US/Emerging markets. This is contrary to the primarily cost-
takeout focus in terms of demand in FY11. We believe this is a structural trend from a
longer-term perspective and is corroborated by near term trends.
We would like to highlight the recent events supporting our thesis that strong
discretionary demand trends will continue:
• Company commentary highlighting the shift in spending priorities at clients in the US
toward discretionary demand being a reason for the sluggishness in US revenue
growth in 4Q FY11 due to allocation decision-making delays.
• SAP and Oracle posting growth comparable to pre-recession growth rates on
application licence sales; Accenture’s consulting growth and signings showing positive
momentum.
• Licence revenue growth seen in Americas and emerging markets exceeding overall
SAP and Oracle license revenue growths.
• New scope TCV showing improving trends, while restructuring TCV shows a decline
based on TPI data.
We believe that, going into FY12F, growth in package implementation will exceed growth
in run-the-business segments as the rollout/upgrades on back of strong new licence
sales at SAP and Oracle translate into downstream implementation work for tier-1 Indian
IT companies. This, in our view, would be a repeat of the scenario in FY07 and FY08,
where package implementation outperformed ADM by a wide margin. Near -term
corroboration of this trend is visible over the past 3 quarters, with package
implementation growth exceeding ADM growth across tier-1 Indian IT companies
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
1Q FY12F results preview
1Q results a window to FY12 and a test of nervous expectations
1Q FY12F: evenue growth of 2-8%, margins to see wage hike impact
We believe investors will look for the following in the 1Q FY12F results: 1)
the impact of macroeconomic deterioration on demand and the outlook for
Indian IT companies; 2) shifting of client spending priorities toward
discretionary spending; 3) continuation of positive pricing momentum; and
4) the impact of an increase in visa rejections on revenue growth and
margins. We expect revenue growth of 2-8% q-q across tier-1 Indian IT
companies (including Cognizant), with Cognizant leading, followed by TCS
and Wipro lagging on growth. Margins across companies are likely to be
impacted by wage inflation, with the exception of HCL Tech. We expect
only a marginal increase in Infosys’ and Cognizant’s guidance for FY12.
Action: Infosys and HCL Tech most preferred, Wipro least preferred
Our stock preferences are driven by our sector stance on preferring
companies which require: 1) lower volume growth to meet growth
expectations (Infosys); 2) greater skew towards discretionary demand
(Infosys, HCL Tech); and 3) market-share-gain-focused companies (HCL
Tech and Cognizant). Our top BUYs in the sector remain Infosys followed
by HCL Tech. We think Cognizant’s future performance may disappoint,
while at TCS valuations leave limited room for upside. Wipro is our least
preferred stock, as results of its restructuring may take time to fructify. We
maintain REDUCE on Mphasis and NEUTRAL on Tech Mahindra.
Catalysts: Guidance upgrades and pricing power a positive
Upgrades in revenue growth guidance at Infosys and Cognizant and
continuation of pricing power momentum could be positive triggers for
stocks. In-line revenues and guidance at Infosys would be taken positively,
in our view, while in-line results at TCS might not provide enough
ammunition to sustain the stock price
1Q FY12F preview – window to FY12
Impact of macro headwinds and discretionary demand
traction needs to be watched
We believe investors will look for the following cues from the 1Q FY12F results of the
Indian IT sector: 1) the impact of macroeconomic deterioration on the demand and
outlook of Indian IT companies; 2) shifting of client spending priorities toward
discretionary spending; 3) continuation of the positive pricing momentum; and 4) the
impact of an increase in the number of visa rejections on revenue growth and margins.
We expect revenue growth of 2-8% q-q across tier-1 Indian IT companies (including
Cognizant), with Cognizant leading, followed by TCS and Wipro lagging on growth.
Margins across companies are likely to be impacted by wage inflation, with the exception
of HCL Tech, where the salary impact comes a quarter ahead.
Cognizant and TCS to lead, Wipro to lag on growth
We expect Cognizant (8% q-q) and TCS (6% q-q) to lead on revenue growth, while
Wipro is likely to lag (2.1% q-q including contribution from SAIC unit acquisition). Infosys
and HCL Tech should be comparable on growth of 4.2-4.6% q-q. On margins, Infosys
should be the worst hit at 250bps, followed by TCS (180bps), Wipro (130bps) and
Cognizant (70bp), in that order. We expect HCL Tech to show a 140bp improvement in
EBITDA margin, in line with guidance. We believe there could be downside surprises to
our Cognizant revenue growth estimates on continuing company-specific weakness in
Europe
Marginal increase in revenue and earnings guidance likely
We expect the FY12 revenue guidance of Infosys and Cognizant to be raised only
marginally by ~100bps to 21% and 30% at the top end, citing macro uncertainty and inline performance. Earnings guidance at Infosys might be raised to INR130 per share (vs
INR128 earlier) at the higher end, we believe. We expect Infosys will guide for ~6% q-q
growth in 2Q FY12F. Upside surprises to our guidance expectation could be positive for
the stocks.
Catalysts
Upgrades in revenue growth guidance at Infosys and Cognizant and continuation of
pricing power momentum could be positive triggers for stocks, in our view. Revenues
and guidance coming in line with our expectations at Infosys would be taken positively, in
our opinion, while in-line results at TCS might not provide enough ammunition for further
stock price appreciation.
Sector view: selectively positive
We have not been in the camp arguing for exuberant revenue growth touching 30%
levels for the tier-1 Indian IT players in FY12. We have maintained that growth would be
healthy, in the 20-25% range for the tier-1 players. Also, our expectations on margin
declines over the period FY11-13F continue to be more pessimistic compared with street
expectations. This is given our belief that supply-side pressures and growth investments
that are required to push growth would pressure margins.
These fears came true in the 4Q FY11 results, when the volume growth across
companies disappointed Street expectations, with pricing being the saving grace in terms
of keeping results in line. This has led to a reset of street expectations in terms of growth
and margins.
We are selectively positive on the sector, with the demand outlook remaining robust
despite macro concerns, given:
• Tech unemployment rate improvement in the US provides greater comfort on demand,
despite macro headwinds.
• Shifting of client spending priorities toward discretionary/front-end facing and
transformational work has been highlighted by recent results at Oracle, SAP and
Accenture, which augur well for companies like Infosys and HCL Tech, in our view.
• Visa and protectionism issues are a nuisance, in our view, leading to procedural delays
and some-fine tuning in terms of staffing — but not necessarily a disruption to the
business of Indian IT players. We do not anticipate major revenue or margin pressures
on account of the elevation in visa rejection rates.
In light of the macro concerns on demand, we suggest backing stocks which require less
volume requirement to meet growth expectations, those that normally gain on
discretionary demand trends, and we prefer market-gain-focused companies, which
typically do well even in slack economic environments. This, coupled with reasonable
valuations, remains the basis for our stock preferences.
Prefer Infosys, HCL Tech; Wipro least preferred
Our top BUYs in the sector remain Infosys followed by HCL Tech. Among our NEUTRAL
ratings, we prefer Cognizant over TCS and Wipro. Our stock preferences are driven by
our sector stance on preferring companies which require:
• Lower volume growth to meet growth expectations (Infosys needs only 17% volume
growth to meet our FY12F revenue growth expectations compared with 24.3% at TCS,
on our estimates). We expect USD revenue growth of 24.3% at Infosys and 25.5% at
TCS in FY12F.
• Greater skew towards discretionary demand (Infosys, HCL Tech), with 22-30% of
revenues coming from discretionary service lines like package implementation and
products,
• Market-share-gain-focused companies (HCL Tech and Cognizant) with higher SGA
spending and lower margin expectations.
We would likely re-evaluate our view on Cognizant on a 5-10% share price correction
from current levels, while at TCS we believe valuations leave limited room for upside.
Wipro is our least preferred stock among tier-1 IT companies as the recent restructuring
could take time to bear fruit, in our view, while also having an impact on revenue growth
and margins in the near term. We maintain REDUCE on Mphasis and NEUTRAL on
Tech Mahindra
What will take stock prices higher?
Infosys: Revenue growth in line with expectations (4.6% q-q) and revenue growth
guidance stronger than 6% q-q for 2Q FY12F would likely be taken positively by the
street, as that would imply a lower hurdle for 2H FY12F for growth expectations to be
met, in our view. This would also provide greater certainty to our belief that: 1) the
restructuring at Infosys is not materially disruptive; and 2) there are no fundamental
issues with demand at Infosys. Continuation of the positive pricing momentum seen in
FY11 (5% constant currency terms pricing increase over the last three quarters) could
push the guidance higher.
HCL Tech: Near-term stock price upside might be capped by flattish commentary on
FY12F margins, despite expected achievement of stated margin improvement in 4Q
FY11F. We believe reinforcement of the strong volume growth trajectory at HCL Tech
would be essential for the stock’s next move up. Longer term, we maintain a positive
view on the stock given revenue momentum. We are not perturbed by management’s
intention of keeping margins flattish as long as the company continues to beat its peers
on revenue and EPS growth.
Cognizant: Cognizant’s return to outperformance over tier-1 Indian IT players on
sequential revenue growth could be a positive trigger. The company has not materially
outperformed tier-1 Indian IT peers on revenue growth over the past three quarters. A
return to revenue growth outperformance could strengthen the case for premium
valuations in our view, given a predictable margin trajectory. Revenue growth guidance
in excess of 31% over FY12F (vs current guidance of 29%) would be a positive stock
trigger, as this would build in acceleration in revenue growth compared with previous
street expectations, in our view.
TCS: Without significantly beating our 6% q-q expectation for 1Q FY12 revenue growth
and visibility of material pricing momentum (an area where pricing commentary of
management has turned more sober over the past three quarters), we believe the stock
might start to underperform on already high street expectations. Our FY12-13F earnings
estimates are lower than Bloomberg consensus expectations by 3-5%.
Wipro: Early signs of a revival in revenue growth post restructuring would be a keenly
watched metric. We believe this is unlikely to materialize in 1Q FY12, and investors
might need to wait for longer for this to be visible. We think the stock carries the risk of
consensus downgrades if revenue growth guidance for 2QFY12F is lower than 5% q-q
(organic growth). Our FY12-13F earnings estimates for Wipro are some 5% lower than
Bloomberg consensus.
Pertinent trends that could shape stock performance in FY12
We highlight four key potential trends that we think are likely to shape stock performance
in FY12-13:
• Sharp decline in US Tech unemployment and countercyclical moves to US
unemployment, providing comfort to the strong IT services demand argument. This is
despite macro deterioration concerns.
• Shift in client spending priorities toward discretionary segments, especially in the US
and emerging markets, indicating to us a shift from a pure cost take-out focus
previously.
• Significant YTD outperformance of MNC stocks, like Accenture, IBM and Cap Gemini
vs Indian IT players, could lead to a shift in investor preferences toward more
reasonably valued Indian IT stocks.
• Price increases in FY11 have been a positive surprise; continuation of this trend in
FY12 could be a positive trigger for the stocks.
Sharp decline in US tech unemployment rate provides
demand comfort, despite macro deterioration
As we see it, divergence in tech unemployment and overall unemployment trends in the
US indicate the clouds on the horizon are not as menacing as made out to be by macro
economic deterioration fears in the US and Europe (key markets for Indian IT). The trend
below clearly indicates that the tech industry continues to do better at job creation
compared to overall US economy. Secondly, periods of low tech unemployment or falling
tech unemployment are typically better in terms of growth for the Indian IT industry. This
has been reflected in the superior industry growth rate in period FY06-08 and then again
in FY11. With tech unemployment falling from a peak of 6.5% in Mar-10 to 3.8% in May-
11, and the tech industry approaching the seasonally stronger tech demand periods, we
believe strong revenue momentum should be sustained for the industry, despite a largely
jobless recovery in the US.
Shift in client spending priorities toward discretionary
demand
We believe a key trend that would shape demand going into FY12F is a shift in spending
priorities toward discretionary demand areas like package implementation and
consulting, especially in the US/Emerging markets. This is contrary to the primarily cost-
takeout focus in terms of demand in FY11. We believe this is a structural trend from a
longer-term perspective and is corroborated by near term trends.
We would like to highlight the recent events supporting our thesis that strong
discretionary demand trends will continue:
• Company commentary highlighting the shift in spending priorities at clients in the US
toward discretionary demand being a reason for the sluggishness in US revenue
growth in 4Q FY11 due to allocation decision-making delays.
• SAP and Oracle posting growth comparable to pre-recession growth rates on
application licence sales; Accenture’s consulting growth and signings showing positive
momentum.
• Licence revenue growth seen in Americas and emerging markets exceeding overall
SAP and Oracle license revenue growths.
• New scope TCV showing improving trends, while restructuring TCV shows a decline
based on TPI data.
We believe that, going into FY12F, growth in package implementation will exceed growth
in run-the-business segments as the rollout/upgrades on back of strong new licence
sales at SAP and Oracle translate into downstream implementation work for tier-1 Indian
IT companies. This, in our view, would be a repeat of the scenario in FY07 and FY08,
where package implementation outperformed ADM by a wide margin. Near -term
corroboration of this trend is visible over the past 3 quarters, with package
implementation growth exceeding ADM growth across tier-1 Indian IT companies
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