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INFORMATION TECHNOLOGY
We expect companies under our coverage to report a sequential revenue
growth of about 3%, largely driven by volumes. Volumes for the Top 4
companies are expected to rise between 3.5% - 5%. Average realizations are
expected to remain stable. Currency volatility should help revenues
marginally - about 50 - 90bps for the top companies.
EBIDTA margins are expected to be lower on a QoQ basis. Several companies
give salary increments to employees during this quarter and we expect that
to have an impact on margins. Apart from the increase in salary bill, other
factors like the appreciation in rupee (1.2% QoQ, approx) may have some
impact on margins.
With tax benefits u/s 10 of the Income Tax Act, 1961 not available WEF FY12,
tax rates for companies are expected to rise. Consequently, PAT is expected
to fall by about 5% for the Top 4 companies and by about 9% for the whole
coverage universe. Among the Top 4, HCLT is expected to report QoQ
growth in PAT of about 9% as compared to de-growth for the remaining 3.
HCLT's EBIDTA margins are expected to improve in line with the stated focus
on profitability. We have given quarterly expectations of Mahindra Satyam
but understand that, the numbers can be materially different from our
expectations.
The guidance from Infosys will be important. While the guidance for 1Q
was muted, Infosys has guided for a strong 5% CQGR for the remaining 3
quarters. Management comments on the macro scene and client spending
will thus gain additional importance.
Among other things, we will also watch out for :
a) Pricing improvements and expectations about the same, b) Comments on
opening up of new opportunities like Cloud Computing, etc c) Further
insights into sustainability of discretionary spends and d) commentary on
concerns relating to visas, etc.
We maintain our optimistic view on the medium-to-long term prospects of
the sector. Over the medium term, we expect large caps to out-perform as
they are better equipped to counter the impact, if any, of appreciating rupee
and any variation in the demand scenario. We will keep a close watch on
the evolving macro scene in developed economies, where recent economic
data is not very encouraging.
Infosys and TCS remain our preferred large-cap picks. In mid-caps, we prefer
NIIT Technologies and KPIT Cummins. Mphasis is not covered here because
quarter ends in July.
3.5% - 5% sequential volume growth expected for top tier companies
We expect top-tier companies to report volume growth of about 3.5% - 5% QoQ.
The expected growth is on the back of consistently improving demand and higher
market share. We understand that, Indian companies have been witnessing continuous
business flows as customers look for better value and reduced costs. In this process,
they are likely gaining additional market share. Infosys is expected to report
subdued growth of about 3.5% in volumes due to volatility in client spending experienced
by it. Recent commentary from peers though, indicates that, they have not
faced any such volatility.
Over the past few quarters, M&A activity in the global BFSI vertical had resulted in
increased business flows. This is now being substituted by more long term and annuity
type of businesses, we believe. Moreover, verticals like manufacturing, which
were slower to start spending, are now seeing increased deal flows, we understand.
While the order flows from US are expected to have grown, we will closely hear
management comments on the potential order flows from Europe and Asia. We do
not expect any major impact of the events in Japan and MENA.
While the order flows from US are expected to have grown, we will closely hear
management comments on the potential order flows from Europe, where economic
news has been a source of worry.
While volumes are expected to rise QoQ, we expect realizations to be largely stable.
However, we will closely watch out for potential price improvements and management
comments regarding these will be of importance to us.
Impact of cross currency movements
The Indian rupee has appreciated v/s USD (1.2%), while it has depreciated against
Euro (4%) and GBP (0.6%). The USD has also depreciated v/s GBP and Euro. To
that extent, USD-based revenues as well as INR-based revenues for the quarter are
expected to be positively impacted. We expect a positive impact of about 0.5% -
1% QoQ in revenues for the top companies.
For the Top 4 companies, we expect revenues to be about 3.2% higher in INR
terms. For the coverage universe, we expect the INR revenues to be at about 2.6%
higher QoQ.
Margins expected to be lower
We expect margins to be lower sequentially. Salary increments and rupee appreciation
(v/s USD) are expected to impact profitability. Cost efficiencies and scale benefits
are expected to set-off the impact partly. Within the Top 4, we expect only
HCLT to report a growth in PAT QoQ on the back of improvement in margins.
Higher tax to result in de-growth in PAT
We expect the tax provisions to shoot up in 1Q as the tax benefits u/s 10 of Income
Tax Act, 1961 expired in FY11. Consequently, PAT is expected to de-grow by about
9% over the previous quarter for our coverage companies.
Factors to watch
The guidance from Infosys will be important. While the guidance for 1Q was muted,
Infosys has guided for a strong 5% CQGR for the remaining 3 quarters.
The management had indicated that, the 1Q revenues will be muted because of
volatile client spending. However, it had also said that, FY12 will be a normal year
as far as demand is concerned. Thus, management comments on the macro scene
and client spending will gain additional importance.
Among other things, we will also watch out for :
Apart from Infosys' guidance, we will closely track a) Pricing improvements and expectations
about the same, b) Comments on opening up of new opportunities like
Cloud Computing, etc c) Further insights into sustainability of discretionary spends
and d) commentary on concerns relating to visas, etc.
We will closely watch the progress made by and expectations of the various companies
in new areas of opportunities. Cloud Computing provides a big potential and
order flows in this business will be of interest to us.
Companies are also now increasingly looking at moving to newer types of pricing
models like outcome-based pricing, transaction-based pricing, etc. Trends in these
will be of interest to us from the point-of-view of margin protection and improvement.
Pricing is expected to have largely stabilized during the quarter and we will watch
out for comments on any potential pricing uptick from clients.
Recommendation
We maintain our positive bias on sector fundamentals over the medium-to-long
term. A slow recovery in the global economy should reflect in increased business for
Indian IT vendors. Indian companies have likely been able to increase their market
share in the global outsourcing pie.
However, the recent economic data from developed economies has not been encouraging.
Developments in Greece have cast a shadow over the financial system of
that region. The US economy has also seen employment and housing scenario deteriorating.
The post - QE2 era will be important from the perspective of sustaining and
improving economic growth. Any major weakness in these economies can impact
demand for Indian IT vendors.
Larger companies are better-equipped to handle the appreciating rupee and any
variation in demand. We prefer Infosys and TCS in the large caps. NIIT Technologies
and KPIT Cummins are the preferred mid cap stocks. We have not covered the estimates
for Mphasis because its quarter ending will be in July
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