Goldman Sachs:: Analyzing risk/reward for large-cap IT in a hard landing scenario

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India: Technology: IT Services
Equity Research
Analyzing risk/reward for large-cap IT in a hard landing scenario
Analyzing risk/reward for large-cap IT – Infosys, TCS, HCLT, Wipro
Despite recent quarterly results and stable outlook comments from most
managements, at least for the near term, IT service stocks have corrected
sharply owing to negative macro headlines from the US and EU. While the
medium- to long-term impact of these events on corporate IT spending is
not clear, we analyze a hard landing scenario for FY2013E and the
risk/reward for the large-cap IT stocks in our coverage.
HL FY2013E: Revenue/EPS growth of 13%/2%(vs current 22%/23%)
Under our hard landing scenario, we calculate revenue growth declining
from 22% to 13% for the large caps. For OPM, we note that EBIT margins
peaked in 2009, expanding by 130 bps despite single digit revenue growth.
However, in a hard landing situation now, we expect companies to
continue investing for future growth and expect margins to compress by
170 bps from our current assumptions. This translates to EBIT growth of
just 3% and EPS growth of 2% for the four companies.
Risk/reward: Further downside of 11%-20%; upside of 24%-39%
In the event of our hard landing materializing, we expect the stocks to trade
lower and use the lower range of their historical trough multiples to set our
valuation range (Infosys 14X; TCS 14X; Wipro 12X; HCLT 10X). In this
scenario, we calculate further downside of 11%-20% for these companies,
vs our current upside potential of 24%-39%. We view HCL Technology and
Infosys as having a favorable risk/reward profile at current levels, offering
35%+ upside to our target prices relative to 21% and 11% downside,
respectively, under our hard landing scenario. TCS, on which we are
Neutral-rated, also has upside of 28% to our target price vs. 15% downside
under our hard landing scenario.
Management comments indicate reasonably positive stance
Recent statements by the management of these companies indicate a
reasonably positive stance toward being able to face current uncertainties.
Most managements also pointed to the experience of tiding over 2008/09
as being useful in facing the current situation. Finally, comments also
indicate a steady demand environment from clients currently, with none of
the companies experiencing any delays in project discussions or contract
awards