India IT Services Apr-Jun 2011 earnings wrap: the start of a sequential, multi-quarter EPS downgrade cycle? We think not:JPMorgan,

Please Share:: India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��


India IT Services
Apr-Jun 2011 earnings wrap: the start of a sequential,
multi-quarter EPS downgrade cycle? We think not


 TCS remains the notable exception. Three of the four large Indian IT
companies (Infosys, Wipro and HCLT) contended with EPS downgrades post
1QFY12; TCS was the notable exception. We believe it might take Infosys 2-3
quarters to catch up with TCS in terms of Q/Q revenue growth, which (in our
view) is factored in at Infosys’ current stock price range of ~Rs2,700-2,800.
Benefits from Wipro’s restructuring have been pushed out by another quarter –
(late 3Q/4Q FY12). TCS continues to cement its “industry bellwether” position.
 More company-specific factors at play in 1QFY12 – we do not see this as
the start of a sequential, multi-quarter earnings downgrade cycle- which is
typical of a recession not priced in. Weak revenue growth from Wipro and
Infosys raises the question as to whether it is a manifestation of macro concerns
or company specific issues. We believe that the sub-par performance is
primarily due to company-specific issues. We expect Cognizant’s results
tomorrow (Aug. 2) to provide further proof of it. (Like TCS, Cognizant is
enjoying market-share gains and we expect its 2QCY11 results and
accompanying management commentary to reflect it.) That said, we caution that
companies have fuller visibility for the next 1-2 quarters only - replenishment of
shorter-term projects must take place for continued revenue momentum beyond
this time period. This is true even in the more normal years.
 We think HCLT, on the other hand, needs to do more on gross margins as
gross margins primarily fund SG&A investments and future revenue
growth. HCLT reported strong revenue growth and EBIT margin expansion of
110 bps. However, the break-up of margin expansion concerns us as gross
margins increased merely 40 bps while much of the margin expansion was
derived from SG&A rationalization, which might impact revenue growth in the
medium-to-long term (FY13). HCLT needs to focus on gross margin
improvement to ensure sustainable revenue and earnings growth beyond FY12.
 Despite greater macro uncertainty in Europe, demand environment there
remains strong. Except for Infosys, all three large Indian IT companies
reported strong revenue growth from the region. In Europe, first-time
outsourcers are embracing offshore services (particularly in Continental Europe)
Also, discretionary demand remains healthy in Europe.
 Pricing was weaker in 1QFY12 as both Infosys and Wipro reported lower (Q/Q)
onsite and offshore billing rates for the quarter, while TCS’ pricing declined
0.5%. We do not read too much into modest pricing declines as this reflects
geographic and service-line mix. However, we believe pricing increases, if any,
will take place in the latter half of the year. Firms will continue to trade off in
favor of volumes if pricing improvement is hard to get. TCS manages this well.
 Unbilled revenues continue to increase for Infosys, TCS and Wipro. We do
not see it as a concern as the increase is largely due to milestone-based invoice
practice in longer-term transformation deals and reflection of more fixed price
projects. Revenues tend to get recognized as efforts get expended through the
execution cycle but the billing cycle is lumpy (in accordance with milestones).
 TCS (OW) remains our top pick in the sector. We retain Neutral on Infosys.