Please Share:: 
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Recent correction in Indian IT was obvious to some extent given increased macro concerns
in US/Europe and sentiment turmoil. While near term headwinds will remain due to high
uncertainty, further material decline seems unlikely (assuming no double dip recession).
Macro headwinds different than those of 2008
�� Recently our US chief economist downgraded her expectation of real GDP growth in US
to 2.4% in 2H11 and now expects a similar pace of expansion in 2012 (versus earlier
expectation of 3%+ growth). This implies that there is likely headroom to avoid a double
dip recession in US.
�� We would like to note that the economic crisis of 2008 in US led to recession in most of
the developed countries and most of large Indian IT companies witnessed qoq decline in
US$ revenues (organic) to an extent of 4-5% each in the immediate two quarters
(3QFY09/4QFY09) before stabilizing since 1QFY10 and entering an accelerated growth
phase thereafter.
�� While the major macro event of 2008 unfolded in the BFSI (with various clients of Indian
IT announcing bankruptcy or getting acquired), the slowdown spread to sectors beyond
BFSI, leading to significant deterioration in earnings and cash flows of many clients of
Indian IT.
�� However we view the current likely slowdown as quite different which is led by sovereign
debt issues in US/Europe. Secondly, our quick checks also indicate that this time the
financial strength of most of the clients of Indian IT companies is in much better shape
versus last slowdown. Our recent check on S&P500’s operating earnings growth still
indicates around 18%/15% growth in CY11/CY12 (up from our early June’11 check of
17%/14% growth). We concede that some downgrades are likely in the coming quarters
given increased macro headwinds post 2QCY11.
�� Emergence of mobile devices and increased regulations post last slowdown in various
sectors is also leading to better revenue visibility for Indian IT in terms of increased
demand for services (which are not highly correlated with macro) beyond traditional
outsourcing.
�� Even in traditional outsourcing, with more large deals up for renewals post 2009 as well as
rising wallet share of Indian IT in renewals, revenue visibility for Indian IT improved post 2009.
Historically, following periods of material slowdown, outsourcing penetration has increased,
benefiting Indian IT, driven by higher demand for cost cutting projects from existing/potential
clients to drive more efficiency gains during periods of slowdown.
�� Further, Indian IT has also started increasingly tapping demand outside its traditional focus
verticals including BFSI, Telecom and Manufacturing and also to markets outside US/UK and
thereby leading to increased market potential for Indian IT of late.
Our quick impact analysis indicates further material correction unlikely
�� We do acknowledge that increased macro concerns through sovereign debt issues in
US/Europe and S&P’s downgrade of the US debt rating may result in some delays in decision
making by clients of Indian IT leading to postponement of earnings growth and resulting
corrections in multiples/stock prices which we have witnessed so far.
�� Our quick and broader check on impact analysis of recent macro headwinds on the sector
earnings growth factoring in the bear case in terms of a slow-down in decision making/budget
spending over the next 2-3 quarters (not assuming a full blown recession in developed
countries) indicates around 7-11% earnings downgrade from FY12-FY14 for most of the large
cap Indian IT names (factoring higher downgrade for HCL Tech).
�� Our bear case assumes i) US$ revenue growth of just 0-2% qoq in 3QFY12/4QFY12 and
US$ revenue downgrade of 5-9% in FY12-FY14; ii) Rupee/US$ appreciation of 1.7%/1.1% for
FY13/FY14 versus our current expectation of 1%/flat.
�� We also believe that our bear case is unlikely unless financial strength of clients of Indian IT
deteriorate materially going forward or there are significant delays in decision making, there
by impacting growth. Secondly in periods of slowdown most Indian IT companies has pulled
out higher margin efficiencies through tighter bench, higher offshoring, increasing variable
portion within employee cost etc. That said, we are still evaluating the impact in detail as well
as trying to understand the impact on demand from various verticals (especially from BFSI).
Our view
�� Therefore we believe that with correction of 10%+ in just last few trading sessions in most of
the Indian IT large caps names largely factors deteriorated sentiments. We do concede that
the macro headwinds are likely to remain in near term due to high uncertainty and increased
risk on earnings/multiples. We believe that valuation multiples are unlikely to correct to
previous bottoms witnessed during last recessionary period (as our bear case analysis
assumes no double dip recession). The valuation multiple will adjust upward in medium to
long term post some clarity and stabilization with regards to global macro uncertainty.
�� Even in our bear case scenario, we believe over the medium to long term, earnings growth
outlook is likely to improve due to acceleration in decision making, thereby offering decent
upside from current levels even on our bear case scenario.
�� The above reflects our quick analysis of increased macro headwinds on the sector and we
are currently evaluating the impact on the earnings and our target price in detail (which could
be different from the impact through our bear case scenario mentioned in this report). We
currently have buy ratings on Infosys/TCS/HCL Tech. Given material correction in HCL Tech
and resulting low valuations, we expect more buying interest in HCL Tech at current levels.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Recent correction in Indian IT was obvious to some extent given increased macro concerns
in US/Europe and sentiment turmoil. While near term headwinds will remain due to high
uncertainty, further material decline seems unlikely (assuming no double dip recession).
Macro headwinds different than those of 2008
�� Recently our US chief economist downgraded her expectation of real GDP growth in US
to 2.4% in 2H11 and now expects a similar pace of expansion in 2012 (versus earlier
expectation of 3%+ growth). This implies that there is likely headroom to avoid a double
dip recession in US.
�� We would like to note that the economic crisis of 2008 in US led to recession in most of
the developed countries and most of large Indian IT companies witnessed qoq decline in
US$ revenues (organic) to an extent of 4-5% each in the immediate two quarters
(3QFY09/4QFY09) before stabilizing since 1QFY10 and entering an accelerated growth
phase thereafter.
�� While the major macro event of 2008 unfolded in the BFSI (with various clients of Indian
IT announcing bankruptcy or getting acquired), the slowdown spread to sectors beyond
BFSI, leading to significant deterioration in earnings and cash flows of many clients of
Indian IT.
�� However we view the current likely slowdown as quite different which is led by sovereign
debt issues in US/Europe. Secondly, our quick checks also indicate that this time the
financial strength of most of the clients of Indian IT companies is in much better shape
versus last slowdown. Our recent check on S&P500’s operating earnings growth still
indicates around 18%/15% growth in CY11/CY12 (up from our early June’11 check of
17%/14% growth). We concede that some downgrades are likely in the coming quarters
given increased macro headwinds post 2QCY11.
�� Emergence of mobile devices and increased regulations post last slowdown in various
sectors is also leading to better revenue visibility for Indian IT in terms of increased
demand for services (which are not highly correlated with macro) beyond traditional
outsourcing.
�� Even in traditional outsourcing, with more large deals up for renewals post 2009 as well as
rising wallet share of Indian IT in renewals, revenue visibility for Indian IT improved post 2009.
Historically, following periods of material slowdown, outsourcing penetration has increased,
benefiting Indian IT, driven by higher demand for cost cutting projects from existing/potential
clients to drive more efficiency gains during periods of slowdown.
�� Further, Indian IT has also started increasingly tapping demand outside its traditional focus
verticals including BFSI, Telecom and Manufacturing and also to markets outside US/UK and
thereby leading to increased market potential for Indian IT of late.
Our quick impact analysis indicates further material correction unlikely
�� We do acknowledge that increased macro concerns through sovereign debt issues in
US/Europe and S&P’s downgrade of the US debt rating may result in some delays in decision
making by clients of Indian IT leading to postponement of earnings growth and resulting
corrections in multiples/stock prices which we have witnessed so far.
�� Our quick and broader check on impact analysis of recent macro headwinds on the sector
earnings growth factoring in the bear case in terms of a slow-down in decision making/budget
spending over the next 2-3 quarters (not assuming a full blown recession in developed
countries) indicates around 7-11% earnings downgrade from FY12-FY14 for most of the large
cap Indian IT names (factoring higher downgrade for HCL Tech).
�� Our bear case assumes i) US$ revenue growth of just 0-2% qoq in 3QFY12/4QFY12 and
US$ revenue downgrade of 5-9% in FY12-FY14; ii) Rupee/US$ appreciation of 1.7%/1.1% for
FY13/FY14 versus our current expectation of 1%/flat.
�� We also believe that our bear case is unlikely unless financial strength of clients of Indian IT
deteriorate materially going forward or there are significant delays in decision making, there
by impacting growth. Secondly in periods of slowdown most Indian IT companies has pulled
out higher margin efficiencies through tighter bench, higher offshoring, increasing variable
portion within employee cost etc. That said, we are still evaluating the impact in detail as well
as trying to understand the impact on demand from various verticals (especially from BFSI).
Our view
�� Therefore we believe that with correction of 10%+ in just last few trading sessions in most of
the Indian IT large caps names largely factors deteriorated sentiments. We do concede that
the macro headwinds are likely to remain in near term due to high uncertainty and increased
risk on earnings/multiples. We believe that valuation multiples are unlikely to correct to
previous bottoms witnessed during last recessionary period (as our bear case analysis
assumes no double dip recession). The valuation multiple will adjust upward in medium to
long term post some clarity and stabilization with regards to global macro uncertainty.
�� Even in our bear case scenario, we believe over the medium to long term, earnings growth
outlook is likely to improve due to acceleration in decision making, thereby offering decent
upside from current levels even on our bear case scenario.
�� The above reflects our quick analysis of increased macro headwinds on the sector and we
are currently evaluating the impact on the earnings and our target price in detail (which could
be different from the impact through our bear case scenario mentioned in this report). We
currently have buy ratings on Infosys/TCS/HCL Tech. Given material correction in HCL Tech
and resulting low valuations, we expect more buying interest in HCL Tech at current levels.
No comments:
Post a Comment