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C Y 1 2 b u d g e t d e c i s i o n s c l o u d ‘ v a l u a t i o n ’ s t a r…
Earlier this week, we concluded our inter quarter discussions with Tier I IT
vendors, the takeaways of which were modestly disheartening. The
discussion suggests that though there were no cancellations or
maintenance project delays yet, instances of ‘discretionary’ projects for
European customers getting pushed out has crept in. Noticeably, there
seems to be ‘ample’ macro anxiety at the CIO level to influence CY12 IT
budgets. Acknowledging it is premature to talk about CY12 IT budgets,
we believe, persistent uncertainty could delay the decision cycle (similar
to CY09) with “doing-more-for-less” getting louder. Further, valuations
could likely remain subdued until concerns over CY12 IT budgets get
alleviated. Consequently, we have lowered our FY13E estimates and our
price target across the board. We reiterate that the risk-reward is
unfavourable in the near term while long-term investors could stay put
with TCS and Infosys.
ƒ Client additions have likely fatigued
Analysing client additions trends since Q1Y07 suggests that client
additions have likely fatigued. During the 2008/2009 recession, new
client additions had bottomed at 26 and 27 additions in Q1FY10
(Q2CY09) for TCS and Infosys, respectively. Noticeably, in Q1FY12,
TCS and Infosys added 24 and 26 clients, respectively, vs. its
historical average (Q1FY07-Q1FY12) of 39 and 37, respectively, and
fewer than the trough of Q1FY10. However, analysing client
transitions suggests improved mining across various bands (Exhibit
2). Finally, though the top 100 clients of Tier I companies contribute
significant portion of their revenues, new client additions help
sustain incremental revenue growth momentum.
ƒ YoY growth across verticals has generally tapered; BFSI feeble
Below we analyse YoY growth trends across key verticals since the
June 2008 quarter. As a general observation, growth rates have
tapered though we acknowledge that client profile, ramp-ups and
level of engagement weigh and remain crucial. YoY growth in the
banking financial services & insurance (BFSI) vertical, which
contributes ~35-40% of revenues, has moderated significantly in
Q1FY12. Notably, Infosys has seen its BFSI growth decline to 20.7%
in Q1FY12 vs. 37% in Q2FY11. Wipro’s manufacturing practice grew
7% YoY in Q1FY12 vs. 68% in Q2FY11 while for Infosys it grew 28%
vs. 31% in Q3FY11. Though TCS’ manufacturing practice grew 38%
YoY in Q1FY12, it had declined for eight consecutive between
Q3FY09 and Q1FY11. HCL Tech’s retail practice was the exception
with growth halving to 25.8% in Q1FY12 vs. 54.9% in Q2FY10 while
it continues to grow at higher rates for others.
ƒ Volumes holding up till now but pricing anxiety remains
Analysing historical volume growth helps draw interesting
observations. TCS and Infosys had reported strong 6% and 6.5%
volume growth, respectively, in Q2FY09 (September 2008), the
quarter of Lehman bankruptcy and 2.4% and 2%, respectively, in
the subsequent (Q3FY09, December 2008) quarter. However,
volumes declined by 2.7%, 1.4% and 6.3% for TCS, Infosys and
Wipro in the Q4FY09 (or Q1CY09) quarter when IT budgets were
likely finalised. This was accompanied by a decline in price
realisations. Noticeably, pricing contribution in TCS’ revenue growth
was -4.8%, -3.3% and -4.2% in FY09, FY10 and FY11, respectively.
ƒ Depreciating rupee may aid operating margins but cross currency
headwinds persist
Intra-quarter, the average rupee rate has depreciated 2.5% against
the US dollar. As a rule of thumb, every 100 bps depreciation of the
rupee yields 25-40 bps in operating margin expansion. This implies
operating margin benefit of 60-100 bps, in Q2FY12, due to currency
alone. However, note that a sharp depreciation of the rupee could
also yield mark-to-market losses on the hedged portfolio and would
be reflected in other income in the profit & loss statement. Further,
were the rupee to remain at current level of | 49 for the remainder of
the year, the average FY12E |/$ rate could be | 47.4 vs. | 44.5
assumed by Infosys in its FY12 guidance (given at the end of
Q1FY12). This denotes 6% depreciation relative to guidance
assumption and could yield operating margin relief of 150-240 bps.
Noticeably, this could lead to Infosys revising its earlier (given at the
end of Q1FY12) operating margin guidance of a 250 bps decline in
FY12. Separately the US dollar has appreciated 1.9%, 2.5% against
the Australian dollar (AU$) and the euro (EUR) and depreciated
0.6% vs. the British pound (GBP) relative to Infosys’ guidance at
Q1FY12. Assuming Q1FY12 currency contribution of 7.5% for AU$
and EUR each and 6.4% for GBP suggests a likely $5.1 million
impact on the Q2FY12 revenue guided range of $1,730-1,755 million
(Exhibit A). Finally, at current rates of 1.36 for EUR/US$, 1.57 for
GBP/US$ and 0.98 for AU$/US$, the average FY12 rates could be
1.39, 1.59 and 0.98, respectively vs. guidance assumption of 1.45,
1.60 and 1.07, respectively. This could negatively impact US$
revenues by $62 million or 1% (Exhibit 10) relative to Infosys’ FY12
guided range.
ƒ Valuation look attractive post correction but not yet on PEG comps
Though IT stocks look attractive post 15-20% correction, we would
like to highlight the PEG comp as well. Based on consensus’ FY13E
estimates, TCS, Infosys and Wipro are trading at 1.1x, 1x and 1x
PEG, respectively. Note the current PEG assumes FY13E earnings
will grow at 16%, 16.7% and 13.1% for TCS, Infosys and Wipro.
While the earnings look achievable in a ‘normal’ year, they look
aggressive pending material deterioration in the macroeconomic
environment.
ƒ Consequently, we cut estimates and price targets sharply
We are adjusting our revenue and EPS estimates sharply for all
stocks. We now expect revenues to grow at 13-14% (Exhibit 16) in
FY13E for Tier-I vendors and earnings to grow in high single digits
(Exhibit 17). Consequently, we have lowered our target multiple for
TCS to 20x vs. 22x earlier, Infosys (19x vs. 21x) and HCL
Technologies (13.2x vs. 14.6x earlier) and maintain for Wipro at 14x.
We have valued TCS at | 1160 (| 1320 earlier), Infosys at | 2820 (|
3350 earlier), Wipro at | 360 (| 390 earlier) and HCL Tech at | 450 (|
535 earlier). We reiterate that the risk-reward is unfavourable in the
near term while long-term investors could stay put with TCS and
Infosys
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
C Y 1 2 b u d g e t d e c i s i o n s c l o u d ‘ v a l u a t i o n ’ s t a r…
Earlier this week, we concluded our inter quarter discussions with Tier I IT
vendors, the takeaways of which were modestly disheartening. The
discussion suggests that though there were no cancellations or
maintenance project delays yet, instances of ‘discretionary’ projects for
European customers getting pushed out has crept in. Noticeably, there
seems to be ‘ample’ macro anxiety at the CIO level to influence CY12 IT
budgets. Acknowledging it is premature to talk about CY12 IT budgets,
we believe, persistent uncertainty could delay the decision cycle (similar
to CY09) with “doing-more-for-less” getting louder. Further, valuations
could likely remain subdued until concerns over CY12 IT budgets get
alleviated. Consequently, we have lowered our FY13E estimates and our
price target across the board. We reiterate that the risk-reward is
unfavourable in the near term while long-term investors could stay put
with TCS and Infosys.
ƒ Client additions have likely fatigued
Analysing client additions trends since Q1Y07 suggests that client
additions have likely fatigued. During the 2008/2009 recession, new
client additions had bottomed at 26 and 27 additions in Q1FY10
(Q2CY09) for TCS and Infosys, respectively. Noticeably, in Q1FY12,
TCS and Infosys added 24 and 26 clients, respectively, vs. its
historical average (Q1FY07-Q1FY12) of 39 and 37, respectively, and
fewer than the trough of Q1FY10. However, analysing client
transitions suggests improved mining across various bands (Exhibit
2). Finally, though the top 100 clients of Tier I companies contribute
significant portion of their revenues, new client additions help
sustain incremental revenue growth momentum.
ƒ YoY growth across verticals has generally tapered; BFSI feeble
Below we analyse YoY growth trends across key verticals since the
June 2008 quarter. As a general observation, growth rates have
tapered though we acknowledge that client profile, ramp-ups and
level of engagement weigh and remain crucial. YoY growth in the
banking financial services & insurance (BFSI) vertical, which
contributes ~35-40% of revenues, has moderated significantly in
Q1FY12. Notably, Infosys has seen its BFSI growth decline to 20.7%
in Q1FY12 vs. 37% in Q2FY11. Wipro’s manufacturing practice grew
7% YoY in Q1FY12 vs. 68% in Q2FY11 while for Infosys it grew 28%
vs. 31% in Q3FY11. Though TCS’ manufacturing practice grew 38%
YoY in Q1FY12, it had declined for eight consecutive between
Q3FY09 and Q1FY11. HCL Tech’s retail practice was the exception
with growth halving to 25.8% in Q1FY12 vs. 54.9% in Q2FY10 while
it continues to grow at higher rates for others.
ƒ Volumes holding up till now but pricing anxiety remains
Analysing historical volume growth helps draw interesting
observations. TCS and Infosys had reported strong 6% and 6.5%
volume growth, respectively, in Q2FY09 (September 2008), the
quarter of Lehman bankruptcy and 2.4% and 2%, respectively, in
the subsequent (Q3FY09, December 2008) quarter. However,
volumes declined by 2.7%, 1.4% and 6.3% for TCS, Infosys and
Wipro in the Q4FY09 (or Q1CY09) quarter when IT budgets were
likely finalised. This was accompanied by a decline in price
realisations. Noticeably, pricing contribution in TCS’ revenue growth
was -4.8%, -3.3% and -4.2% in FY09, FY10 and FY11, respectively.
ƒ Depreciating rupee may aid operating margins but cross currency
headwinds persist
Intra-quarter, the average rupee rate has depreciated 2.5% against
the US dollar. As a rule of thumb, every 100 bps depreciation of the
rupee yields 25-40 bps in operating margin expansion. This implies
operating margin benefit of 60-100 bps, in Q2FY12, due to currency
alone. However, note that a sharp depreciation of the rupee could
also yield mark-to-market losses on the hedged portfolio and would
be reflected in other income in the profit & loss statement. Further,
were the rupee to remain at current level of | 49 for the remainder of
the year, the average FY12E |/$ rate could be | 47.4 vs. | 44.5
assumed by Infosys in its FY12 guidance (given at the end of
Q1FY12). This denotes 6% depreciation relative to guidance
assumption and could yield operating margin relief of 150-240 bps.
Noticeably, this could lead to Infosys revising its earlier (given at the
end of Q1FY12) operating margin guidance of a 250 bps decline in
FY12. Separately the US dollar has appreciated 1.9%, 2.5% against
the Australian dollar (AU$) and the euro (EUR) and depreciated
0.6% vs. the British pound (GBP) relative to Infosys’ guidance at
Q1FY12. Assuming Q1FY12 currency contribution of 7.5% for AU$
and EUR each and 6.4% for GBP suggests a likely $5.1 million
impact on the Q2FY12 revenue guided range of $1,730-1,755 million
(Exhibit A). Finally, at current rates of 1.36 for EUR/US$, 1.57 for
GBP/US$ and 0.98 for AU$/US$, the average FY12 rates could be
1.39, 1.59 and 0.98, respectively vs. guidance assumption of 1.45,
1.60 and 1.07, respectively. This could negatively impact US$
revenues by $62 million or 1% (Exhibit 10) relative to Infosys’ FY12
guided range.
ƒ Valuation look attractive post correction but not yet on PEG comps
Though IT stocks look attractive post 15-20% correction, we would
like to highlight the PEG comp as well. Based on consensus’ FY13E
estimates, TCS, Infosys and Wipro are trading at 1.1x, 1x and 1x
PEG, respectively. Note the current PEG assumes FY13E earnings
will grow at 16%, 16.7% and 13.1% for TCS, Infosys and Wipro.
While the earnings look achievable in a ‘normal’ year, they look
aggressive pending material deterioration in the macroeconomic
environment.
ƒ Consequently, we cut estimates and price targets sharply
We are adjusting our revenue and EPS estimates sharply for all
stocks. We now expect revenues to grow at 13-14% (Exhibit 16) in
FY13E for Tier-I vendors and earnings to grow in high single digits
(Exhibit 17). Consequently, we have lowered our target multiple for
TCS to 20x vs. 22x earlier, Infosys (19x vs. 21x) and HCL
Technologies (13.2x vs. 14.6x earlier) and maintain for Wipro at 14x.
We have valued TCS at | 1160 (| 1320 earlier), Infosys at | 2820 (|
3350 earlier), Wipro at | 360 (| 390 earlier) and HCL Tech at | 450 (|
535 earlier). We reiterate that the risk-reward is unfavourable in the
near term while long-term investors could stay put with TCS and
Infosys
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