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Sep-11 quarter likely to be along expected lines for large-cap Indian IT:
We expect TCS to lead on Q/Q revenue growth, with Infosys/HCLT coming in
behind. Wipro is likely to have a muted quarter, with its promise of growth
catch-up with peers by 4Q FY12 intact. TCS could see 5.5%+US$ revenue
growth (Q/Q). We estimate Infosys’ Q/Q revenue growth at 5%, and HCLT’s,
being affected the most by US$ strength (cross-currency), at 4%. Wipro’s
organic growth is likely to remain weak at ~1% Q/Q, within its guidance range
of 0-2%. We expect the cross-currency impact (strong US$ vs. other currencies)
to pose Q/Q revenue (US$) growth headwinds of 0.4%-0.6% for
Infosys/TCS/Wipro (with the impact on HCLT the most adverse at ~ 1.2%).
Infosys could reduce its FY12 (US$) revenue growth guidance from 18-
20% to 16-18% due to US$ appreciation (negative cross-currency), and
delays in decision-making: We expect cautious commentary from Infosys and
Wipro on the demand outlook, although Wipro might acknowledge that the
weakness stems from its own restructuring. Wipro’s revenue guidance for 3Q
FY11 is critical, in our view, as it would indicate whether the company is on
track to meet its stated intent to catch up with peers’ growth by 4Q FY12 (3Q
FY12 is the connecting bridge). We estimate 3% Q/Q growth guidance.
Despite macro concerns, commentary from TCS on the IT services
spending outlook (including discretionary spending) is likely to remain
confident, though with incremental due caution: We believe that IT Services
spending since 2008 has been largely disciplined and thougtful after declining
significantly after the Lehman crisis. Since 2008, US IT services spending as a
percent of US GDP and as a percent of corporate profits has moderated,
signifying that excesses have not been built in the system. Further, Accenture
reported (in its 4Q FY11 earnings results, earlier this week) heartening bookings
of $4.2B for consulting and $4.3B for outsourcing, with a book-to-bill ratio of
1.1x and 1.5x, respectively, suggesting that clients continue to invest for growth
beyond the current potential downturn. Moreoever, within the IT Services
spectrum, offshore IT services tend to be the least cyclical and more of a play on
operations/IT than capex/discretionary spend. We expect HCLT to reiterate its
confidence in large deals opening up in 2H CY11. Companies are likely to stay
away from commentary on CY12 IT budgets (it’s too early).
We expect Infosys’ EBIT margin to expand 200bp Q/Q due to higher
utilization, weak Rs and wage normalization: TCS’ operating margin could
increase ~50bp, lower than Infosys’ Q/Q increase, on account of promotionrelated
wage rises in Sep-11 (80bp margin headwind). HCLT’s/Wipro’s (IT
services) EBIT margins are likely to decline about 150bp due to wage rises.
Keep an eye on forex (hedging) losses due to the sharp Rs depreciation and
cross currency movements: We expect TCS’ hedging loss due to its larger
hedged book to be Rs1.75B. Infosys (Neutral) and HCLT (OW) should report
much lower hedging losses due to their lower hedge book.
Stay OW on selected stocks: We would view a further rally in Infosys, either
towards or beyond our Mar-12 PT of Rs2,700, as an opportunity to book profit.
We foresee a replay of what happened this time last year, when the stock rallied
ahead of 2Q FY11 results and subsequently fell. TCS (OW) still our top pick.
Points to watch for
Too early to expect any (concrete) indication on CY12 IT budgets: We would
welcome any initial commentary on CY12 IT budgets, but we do not expect much
color, as it is too early for that. We believe that clients might have just started their
budgeting process for CY12 and IT services budgets are unlikely to be finalized
before December (provided they are not delayed due to macro weakness). We do not
foresee a significant decline (Y/Y) in IT budgets, if at all.
Expect IT spending outlook commentary to be positive with slight caution
despite weak macro environment: We expect TCS and HCLT to remain positive
on the demand environment, and Infosys to remain cautious due to the weakening
macro environment. Infosys could reduce its FY12 US$ revenue growth guidance
modestly (1-2%). We believe that clients are cautious, but that IT services budgets
are intact and decisions are being made, albeit with modest delays. We note that
clients have been disciplined and thoughtful in deciding their IT services budgets
since the CY08 downturn. For example, since 2008, US IT services spending as a
percent of US GDP and as a percent of US corporate profits has actually decreased.
Hence, there appears to be limited room to reduce budgets further. Please refer to our
report, Lessons from the 2008 recession - Part 2: Stronger business models coupled
with moderating valuations (dated Sep 7, 2011). Importantly, we expect a market
share shift in favor of TCS, HCLT and Cognizant, which is likely to make these three
firms more confident about growth prospects than others.
Discretionary spending should remain strong. As indicated by Accenture’s 4Q
FY11 results and commentary (quarter ending Aug-11), the discretionary spending
outlook remains strong. We note that in addition to strong revenue growth, Accenture
reported fairly robust bookings ($4.2B for consulting and $4.3B for outsourcing)
with a book-to-bill ratio of 1.5x for outsourcing and 1.1x for consulting, which is a
leading indicator pointing to a robust demand environment (including for
discretionary projects). Moreover, Indian IT service companies have indicated that
clients had cut their discretionary budgets significantly after the Lehman crisis and,
since then, have been investing only in critical and strategic projects. Cognizant
pointed out in its recent investor calls that clients are committed to protecting these
programs; therefore we see limited downside risk to discretionary spending.
Notably, customers are willing to look beyond the current weakness and plan to
invest to gain a competitive advantage and superior revenue growth after this
(potential) downturn. Moreover, clients are more receptive to new themes such as
cloud, mobility and analytics, and they intend to build capabilities to remain
competitive. We would also look for incremental color on compliance/regulation
work in BFSI.
Both push and pull factors at play: “Push” refers to Indian IT selling its existing
value proposition to first time outsourcers (FTOs) and newer verticals in times of
economic turmoil such as today. For example, Cognizant believes that despite huge
economic uncertainty in Europe, the offshore outsourcing proposition has achieved
penetration of just 10% there. “Pull” relates to Indian IT enhancing its value
proposition through forays into areas such as cloud computing, analytics, mobility,
more sophisticated methods of complex program management, and productivitybased
pricing. Much of the appeal associated with the Pull factor was
developed/solidified in the past three years. The “pull” factor has not received due
recognition from investors, in our view. A silver lining in the Lehman crisis was that
firms such as TCS/Cognizant have expanded addressable market since then thanks to
both the push and pull factors.
Pricing should remain broadly flat: We would seek color on the future pricing
environment. Generally, downward price negotiations are one of the initial
indications of weakness in the demand environment, but Indian IT companies have
been insisting that no such discussions have taken place so far and are converting
pricing discussions to productivity-based measures.
September-11 preview – Company-specific comments
TCS likely to lead with 5.7% Q/Q US$-based revenue growth, primarily driven
by strong volume growth: We expect TCS to maintain its revenue growth
momentum and report quarterly revenues of about $2.5 billion. However, we model a
moderation in revenue growth in the second half of FY12. We model 26.0% US$
revenue growth for FY12, which will require a CQGR of about 3.2% for the
remaining two quarters (which we believe is achievable provided the company meets
our 2Q estimate). TCS is likely to provide positive commentary on the demand
environment. We expect 2Q operating/EBIT margins to increase by 50bp Q/Q after
the 210bp decline last quarter due to wage increases. Margin expansion from US$
appreciation is likely to be diluted by promotion-related wage increases in Sep-11
(80bp margin headwind). We estimate 2Q FY12 EPS to increase by about 1% Y/Y,
despite the 10% increase in EBIT, primarily due to significant hedging losses (about
Rs1.75 billion).
We expect Infosys to deliver US$ revenue growth of ~5.1% Q/Q in 2Q and to
bring down FY12 constant-currency guidance modestly: We expect Infosys to
report 5.1% US$ revenue growth, slightly ahead of the upper end of guidance (5.0%
Q/Q). Volume growth is likely to drive revenue growth, while cross currency should
cause revenue headwind of about 0.3-0.5%. Notably, we expect Infosys to reduce its
FY12 US$ revenue growth guidance from 18-20% to 16-18%, adjusting for
incremental weakness in the macro environment and US$ appreciation. FY12 US$
revenue growth of 18.0% would imply ~3.7% CQGR for the remaining two quarters
(provided the company meets our 2Q FY12 estimates) of the year. 2Q FY12 margins
are likely to expand 200bp Q/Q after declining 300bp last quarter (1Q FY12) due to
wage increases. Increased utilization, strong US$ (vs. the rupee) and wage
normalization should contribute to margin expansion. Infosys is likely to remain
cautious in its commentary on demand outlook. We will be looking for incremental
information on management restructuring and its initial results. Our channel checks
suggest that Infosys has become aggressive in its pricing to gain market share, and
we will seek color on that.
Wipro’s organic revenue growth is likely to remain tepid; we will seek color on
the fruits of restructuring as indicated by revenue growth guidance for 3Q
FY12 (Dec-11 quarter): We expect Wipro (Global IT) to deliver 1.0% Q/Q US$
revenue growth (organic) in 2Q FY12, significantly below that of TCS and Infosys.
We estimate IT services’ EBIT margins to decline 180bp to 20.2% due to wage rises
(US$ appreciation should offset some of the impact) effective July. We forecast EPS
to decline about 7-8% due to weak growth and lower margins. Wipro is likely to
report the lowest EBIT (absolute basis) and EPS in the last six quarters. Wipro’s
revenue guidance for 3Q FY11 is critical as it would indicate whether the company is
on track to meet its stated intent to catch up with peers’ growth by 4Q FY12 (3Q
FY12 is the connecting bridge). We estimate 3% Q/Q growth guidance. We maintain
our view that Wipro is a FY13 story as structural changes take time to convert into
numbers.
HCLT’ should continue to report strong revenue growth (constant currency);
but gross margin performance is the most important factor to look for: We
expect HCLT to report 4.0% Q/Q US$ revenue growth in 2Q FY12 (after adjusting
for cross-currency headwinds of 1.2%). We estimate EBIT margins to decline 150bp
to 13.5% due to wage rises (~200bp) and hiring of freshers (~50bp), partially offset
by strong US$ (about 100bp). We forecast 1Q FY12 EPS to decline about 2% to
~Rs6.9. Management is likely to reiterate its intention to keep EBIT margins at about
14%. The company is well placed to maintain revenue growth despite weakening
macros as management has clearly articulated its strategy to focus on revenue growth
than margins. We expect HCLT to reiterate its confidence in large deals opening up
in 2H CY11. Though gross margins are likely to decline due to wage increases, the
movement in gross margins is important to watch. We believe that lower EBIT
margins are acceptable if a company is making investments in sales and marketing,
but gross margins must be maintained to keep the long-term growth prospects
protected. We would also seek color on the progress on BPO restructuring.
Hedging losses should offset part of the benefits from US$ appreciation against
the rupee: Indian IT companies’ EBIT margins are likely to expand due to US$
strength (or rupee weakness), but the four large-cap firms have varying hedges which
would dilute this positive impact to varying degrees. TCS and Wipro are more
hedged, so their margin upside is likely to be limited. For example, we expect TCS to
bear hedging losses of Rs1,750 million (Rs1.75 billion), including Rs450 million
from ($1.1 billion) 2Q hedges and Rs1,500 million due to mark-to-market of future
hedges, with a modest tailwind (of about Rs250 million) from translation benefits (of
balance sheet accounts).
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Sep-11 quarter likely to be along expected lines for large-cap Indian IT:
We expect TCS to lead on Q/Q revenue growth, with Infosys/HCLT coming in
behind. Wipro is likely to have a muted quarter, with its promise of growth
catch-up with peers by 4Q FY12 intact. TCS could see 5.5%+US$ revenue
growth (Q/Q). We estimate Infosys’ Q/Q revenue growth at 5%, and HCLT’s,
being affected the most by US$ strength (cross-currency), at 4%. Wipro’s
organic growth is likely to remain weak at ~1% Q/Q, within its guidance range
of 0-2%. We expect the cross-currency impact (strong US$ vs. other currencies)
to pose Q/Q revenue (US$) growth headwinds of 0.4%-0.6% for
Infosys/TCS/Wipro (with the impact on HCLT the most adverse at ~ 1.2%).
Infosys could reduce its FY12 (US$) revenue growth guidance from 18-
20% to 16-18% due to US$ appreciation (negative cross-currency), and
delays in decision-making: We expect cautious commentary from Infosys and
Wipro on the demand outlook, although Wipro might acknowledge that the
weakness stems from its own restructuring. Wipro’s revenue guidance for 3Q
FY11 is critical, in our view, as it would indicate whether the company is on
track to meet its stated intent to catch up with peers’ growth by 4Q FY12 (3Q
FY12 is the connecting bridge). We estimate 3% Q/Q growth guidance.
Despite macro concerns, commentary from TCS on the IT services
spending outlook (including discretionary spending) is likely to remain
confident, though with incremental due caution: We believe that IT Services
spending since 2008 has been largely disciplined and thougtful after declining
significantly after the Lehman crisis. Since 2008, US IT services spending as a
percent of US GDP and as a percent of corporate profits has moderated,
signifying that excesses have not been built in the system. Further, Accenture
reported (in its 4Q FY11 earnings results, earlier this week) heartening bookings
of $4.2B for consulting and $4.3B for outsourcing, with a book-to-bill ratio of
1.1x and 1.5x, respectively, suggesting that clients continue to invest for growth
beyond the current potential downturn. Moreoever, within the IT Services
spectrum, offshore IT services tend to be the least cyclical and more of a play on
operations/IT than capex/discretionary spend. We expect HCLT to reiterate its
confidence in large deals opening up in 2H CY11. Companies are likely to stay
away from commentary on CY12 IT budgets (it’s too early).
We expect Infosys’ EBIT margin to expand 200bp Q/Q due to higher
utilization, weak Rs and wage normalization: TCS’ operating margin could
increase ~50bp, lower than Infosys’ Q/Q increase, on account of promotionrelated
wage rises in Sep-11 (80bp margin headwind). HCLT’s/Wipro’s (IT
services) EBIT margins are likely to decline about 150bp due to wage rises.
Keep an eye on forex (hedging) losses due to the sharp Rs depreciation and
cross currency movements: We expect TCS’ hedging loss due to its larger
hedged book to be Rs1.75B. Infosys (Neutral) and HCLT (OW) should report
much lower hedging losses due to their lower hedge book.
Stay OW on selected stocks: We would view a further rally in Infosys, either
towards or beyond our Mar-12 PT of Rs2,700, as an opportunity to book profit.
We foresee a replay of what happened this time last year, when the stock rallied
ahead of 2Q FY11 results and subsequently fell. TCS (OW) still our top pick.
Points to watch for
Too early to expect any (concrete) indication on CY12 IT budgets: We would
welcome any initial commentary on CY12 IT budgets, but we do not expect much
color, as it is too early for that. We believe that clients might have just started their
budgeting process for CY12 and IT services budgets are unlikely to be finalized
before December (provided they are not delayed due to macro weakness). We do not
foresee a significant decline (Y/Y) in IT budgets, if at all.
Expect IT spending outlook commentary to be positive with slight caution
despite weak macro environment: We expect TCS and HCLT to remain positive
on the demand environment, and Infosys to remain cautious due to the weakening
macro environment. Infosys could reduce its FY12 US$ revenue growth guidance
modestly (1-2%). We believe that clients are cautious, but that IT services budgets
are intact and decisions are being made, albeit with modest delays. We note that
clients have been disciplined and thoughtful in deciding their IT services budgets
since the CY08 downturn. For example, since 2008, US IT services spending as a
percent of US GDP and as a percent of US corporate profits has actually decreased.
Hence, there appears to be limited room to reduce budgets further. Please refer to our
report, Lessons from the 2008 recession - Part 2: Stronger business models coupled
with moderating valuations (dated Sep 7, 2011). Importantly, we expect a market
share shift in favor of TCS, HCLT and Cognizant, which is likely to make these three
firms more confident about growth prospects than others.
Discretionary spending should remain strong. As indicated by Accenture’s 4Q
FY11 results and commentary (quarter ending Aug-11), the discretionary spending
outlook remains strong. We note that in addition to strong revenue growth, Accenture
reported fairly robust bookings ($4.2B for consulting and $4.3B for outsourcing)
with a book-to-bill ratio of 1.5x for outsourcing and 1.1x for consulting, which is a
leading indicator pointing to a robust demand environment (including for
discretionary projects). Moreover, Indian IT service companies have indicated that
clients had cut their discretionary budgets significantly after the Lehman crisis and,
since then, have been investing only in critical and strategic projects. Cognizant
pointed out in its recent investor calls that clients are committed to protecting these
programs; therefore we see limited downside risk to discretionary spending.
Notably, customers are willing to look beyond the current weakness and plan to
invest to gain a competitive advantage and superior revenue growth after this
(potential) downturn. Moreover, clients are more receptive to new themes such as
cloud, mobility and analytics, and they intend to build capabilities to remain
competitive. We would also look for incremental color on compliance/regulation
work in BFSI.
Both push and pull factors at play: “Push” refers to Indian IT selling its existing
value proposition to first time outsourcers (FTOs) and newer verticals in times of
economic turmoil such as today. For example, Cognizant believes that despite huge
economic uncertainty in Europe, the offshore outsourcing proposition has achieved
penetration of just 10% there. “Pull” relates to Indian IT enhancing its value
proposition through forays into areas such as cloud computing, analytics, mobility,
more sophisticated methods of complex program management, and productivitybased
pricing. Much of the appeal associated with the Pull factor was
developed/solidified in the past three years. The “pull” factor has not received due
recognition from investors, in our view. A silver lining in the Lehman crisis was that
firms such as TCS/Cognizant have expanded addressable market since then thanks to
both the push and pull factors.
Pricing should remain broadly flat: We would seek color on the future pricing
environment. Generally, downward price negotiations are one of the initial
indications of weakness in the demand environment, but Indian IT companies have
been insisting that no such discussions have taken place so far and are converting
pricing discussions to productivity-based measures.
September-11 preview – Company-specific comments
TCS likely to lead with 5.7% Q/Q US$-based revenue growth, primarily driven
by strong volume growth: We expect TCS to maintain its revenue growth
momentum and report quarterly revenues of about $2.5 billion. However, we model a
moderation in revenue growth in the second half of FY12. We model 26.0% US$
revenue growth for FY12, which will require a CQGR of about 3.2% for the
remaining two quarters (which we believe is achievable provided the company meets
our 2Q estimate). TCS is likely to provide positive commentary on the demand
environment. We expect 2Q operating/EBIT margins to increase by 50bp Q/Q after
the 210bp decline last quarter due to wage increases. Margin expansion from US$
appreciation is likely to be diluted by promotion-related wage increases in Sep-11
(80bp margin headwind). We estimate 2Q FY12 EPS to increase by about 1% Y/Y,
despite the 10% increase in EBIT, primarily due to significant hedging losses (about
Rs1.75 billion).
We expect Infosys to deliver US$ revenue growth of ~5.1% Q/Q in 2Q and to
bring down FY12 constant-currency guidance modestly: We expect Infosys to
report 5.1% US$ revenue growth, slightly ahead of the upper end of guidance (5.0%
Q/Q). Volume growth is likely to drive revenue growth, while cross currency should
cause revenue headwind of about 0.3-0.5%. Notably, we expect Infosys to reduce its
FY12 US$ revenue growth guidance from 18-20% to 16-18%, adjusting for
incremental weakness in the macro environment and US$ appreciation. FY12 US$
revenue growth of 18.0% would imply ~3.7% CQGR for the remaining two quarters
(provided the company meets our 2Q FY12 estimates) of the year. 2Q FY12 margins
are likely to expand 200bp Q/Q after declining 300bp last quarter (1Q FY12) due to
wage increases. Increased utilization, strong US$ (vs. the rupee) and wage
normalization should contribute to margin expansion. Infosys is likely to remain
cautious in its commentary on demand outlook. We will be looking for incremental
information on management restructuring and its initial results. Our channel checks
suggest that Infosys has become aggressive in its pricing to gain market share, and
we will seek color on that.
Wipro’s organic revenue growth is likely to remain tepid; we will seek color on
the fruits of restructuring as indicated by revenue growth guidance for 3Q
FY12 (Dec-11 quarter): We expect Wipro (Global IT) to deliver 1.0% Q/Q US$
revenue growth (organic) in 2Q FY12, significantly below that of TCS and Infosys.
We estimate IT services’ EBIT margins to decline 180bp to 20.2% due to wage rises
(US$ appreciation should offset some of the impact) effective July. We forecast EPS
to decline about 7-8% due to weak growth and lower margins. Wipro is likely to
report the lowest EBIT (absolute basis) and EPS in the last six quarters. Wipro’s
revenue guidance for 3Q FY11 is critical as it would indicate whether the company is
on track to meet its stated intent to catch up with peers’ growth by 4Q FY12 (3Q
FY12 is the connecting bridge). We estimate 3% Q/Q growth guidance. We maintain
our view that Wipro is a FY13 story as structural changes take time to convert into
numbers.
HCLT’ should continue to report strong revenue growth (constant currency);
but gross margin performance is the most important factor to look for: We
expect HCLT to report 4.0% Q/Q US$ revenue growth in 2Q FY12 (after adjusting
for cross-currency headwinds of 1.2%). We estimate EBIT margins to decline 150bp
to 13.5% due to wage rises (~200bp) and hiring of freshers (~50bp), partially offset
by strong US$ (about 100bp). We forecast 1Q FY12 EPS to decline about 2% to
~Rs6.9. Management is likely to reiterate its intention to keep EBIT margins at about
14%. The company is well placed to maintain revenue growth despite weakening
macros as management has clearly articulated its strategy to focus on revenue growth
than margins. We expect HCLT to reiterate its confidence in large deals opening up
in 2H CY11. Though gross margins are likely to decline due to wage increases, the
movement in gross margins is important to watch. We believe that lower EBIT
margins are acceptable if a company is making investments in sales and marketing,
but gross margins must be maintained to keep the long-term growth prospects
protected. We would also seek color on the progress on BPO restructuring.
Hedging losses should offset part of the benefits from US$ appreciation against
the rupee: Indian IT companies’ EBIT margins are likely to expand due to US$
strength (or rupee weakness), but the four large-cap firms have varying hedges which
would dilute this positive impact to varying degrees. TCS and Wipro are more
hedged, so their margin upside is likely to be limited. For example, we expect TCS to
bear hedging losses of Rs1,750 million (Rs1.75 billion), including Rs450 million
from ($1.1 billion) 2Q hedges and Rs1,500 million due to mark-to-market of future
hedges, with a modest tailwind (of about Rs250 million) from translation benefits (of
balance sheet accounts).
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