IT - Growth moderating; Edelweiss

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The CNX IT Index has outperformed the Nifty by 18% in the past three months due to INR depreciation and the positive commentary on demand. Based on our interactions with tier-1 IT companies, we believe decision making has slowed down and ramp ups are behind schedule. Pricing scenario has moderated with even inflation linked increases being denied. We are lowering our growth assumptions and building in marginal price declines but the assumption of INR50/USD as against INR46/USD currently is leading to an upgrade of 1%-8% in earnings for FY13. We believe stocks could correct 8%-10% due to moderation in growth. We maintain Buy on TCS and HCLT and HOLD on Infosys and Wipro.

From confidence to optimism, IT majors reflect macro realities

Until recently, tier-1 IT companies sounded confident due to the strong activity in September and October. But we sense a change in the commentary now. While TCS is witnessing an increase in offshoring, we understand, there is lower optimism from business heads and sales people due to macro nervousness. We believe that the annual shutdowns/furloughs though seasonal are higher this year and would impact growth in Q3FY12. The Tier-1 IT companies have seen a slowdown in deal decision making and rampups are lagging expected milestones. Along with Telecom, We believe growth will slowdown in BFSI, retail and manufacturing due to delay in decision making.              

Lowering revenue, volume growth expectations

We expect revenue growth to moderate in Q3FY12 to about 2%-3% QoQ for Tier-1 companies against expectation of 5% at the beginning of the quarter. Volume growth expectation for TCS has moderated to about 3.5% QoQ for Q3FY12 and Q4FY12, from the earlier 5%. Infosys has indicated that it would be able to meet the lower-end of the guidance range (3.2% QoQ) as against Street expectation of 5% earlier. The growth outlook for Q4FY12 too seems modest. Infosys believes that it would be difficult to replicate FY12 growth in FY13 as budgets would be lower besides under spending. TCS, we believe, has been unable to get inflation linked pricing increases in Q3FY12, which it did in 1HFY12. We are lowering our revenue growth forecast from 17%-20% earlier to about 12%-14% for FY13 for Tier-1 IT companies including 2% reduction in pricing.

Outlook: INR offering respite

While we are modifying our growth expectations down, we revise earnings up by 1%-8% due to the exchange rate assumption of INR 50/USD for FY13 (INR46/USD earlier). We feel there could be a likely correction of about 8%-10% in Tier-1 IT stocks due to moderation in growth. We continue to prefer TCS due to strong deal wins in the recent past and HCLT for its valuation support and a strong order book. Wipro is trading at a 5% discount to Infosys and needs to deliver on the expectation of an improvement in revenue growth trajectory. Infosys, we believe, would see near-term pressure due to dependence on short-term projects and higher exposure to discretionary spending.  We maintain ‘BUY’ on TCS and HCLT and ‘HOLD’ on Infosys and Wipro.