Indian IT Services 1Q Preview: More of the same? Macquarie Research,

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Indian IT Services
1Q Preview: More of the same?
Event
􀂃 We present our 1Q preview for Indian IT vendors as quarterly results season
kicks off next week. We expect 1Q results to be an indicator of steady
demand, though strong stock rallies might be difficult as investors grapple with
demand forecast beyond next two quarters. Our preferred picks remain –
Infosys, TCS and HCLT. We continue to rate HEXW as our preferred midcap
pick but post surge in the stock price in last two weeks we would wait for
better entry point. (For company specific financial forecasts see pages 5–10).
Impact
􀂃 1Q results unlikely to change the tone. We maintain our bullish call on
demand for FY12 but recognise that investors might not bid prices up till there
is more clarity on future growth outlook. We expect to get a better sense of
the same by (a) stronger than expected quarterly performance and/or, (b)
initial comments from corporate on CY12 budgets in early November. We
expect it to be more of the later.
􀂃 Demand looks steady – for now. Oracle and Accenture gave quarterly
results last week which had positive read through emanating from strong
growth across verticals for Accenture (Figure 2-4) and 19% YoY growth in
new licence sales for Oracle (Figure 5). Further, our channel checks in early
June did not hint an impending slow down on revenue growth. We forecast 3-
6% QoQ growth in US$ revenues for large caps and don’t expect major
surprise in 2Q guidance.
􀂃 Margins under seasonal pressure due to wage hikes. Depending on the
nature of the wage hike cycle the pressure on margins due to 12-15% wage
hike would play out over 1Q and 2Q.
􀂃 Steep rise in tax rates to kick in – mid-caps bear the brunt. As widely
known, Indian IT vendors would not get tax incentives from STPI exports from
April 2011 onwards. The end of tax holiday would have earning impact on all
the players – with mid-caps worst hit. Amongst our coverage universe we see
the maximum swing in tax rate for MPHL, RLTA and PSYS (See Fig 6 for
comparison of FY10-12E tax rates for Macquarie IT Stock universe).
Outlook
􀂃 Our preferred stock picking list remains unchanged. Our positive
investment bias keeps us constructive on the space. Infosys, TCS and HCLT
remain our highest conviction ideas.
􀂃 Where are we different from street – HCLT. Our quarterly estimates for
HCLT are 6% ahead of the street on PAT and we remain comfortable with our
thesis on margin expansion playing out as top-line momentum continues.
􀂃 HEXW – top mid-cap pick based on our 3Ps model. In our recent report
Mid-cap mantra for growth, we had argued our investment case on mid-cap IT
names. We screened six names on three key parameters – Positioning,
Profitability and PERs. Hexaware emerged as our top-pick.