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IT services (Mitali Ghosh, Pratish Krishnan, Kunal Tayal)
Neutral
Key drivers of sector outlook
�� Demand holding up amid increased macro risks: Despite a spate of cuts to
2012 GDP forecasts, on-ground checks reveal that demand for Indian offshore
vendors remains intact given an environment of slow growth and tight budgets is
propelling use of services by offshore vendors.
�� Consensus EPS estimates likely to see upward revisions driven by the steep 7%
INR-US$ depreciation exchange rate even in the last one month. We estimate
EPS sensitivity for top-four vendors as 1.2-3% for every 1% change, on an unhedged
basis.
�� Among the services, we expect growth for vendors to be led by run-thebusiness
services (non-discretionary), especially infrastructure management
services (IMS). Growth for IMS is likely to be driven by market-share gain for
Indian vendors, helped by a large pipeline of legacy deals, currently with western
SIs, coming up for renewal.
�� Given an uncertain macro climate and likely quarterly review of IT budgets in
2012, discretionary spends (services like application development and
package implementation) may see slower growth. However, unlike 2008,
discretionary IT demand has not dried up and is being driven by spends on
regulation, business optimization including adoption of technologies like cloud
and analytics and business transformation to address an increasingly digital
consumer and employee, globalization and growing ‘mobility’.
�� Pricing: We see twin trends of commoditization of “run-the-business” activities
of application maintenance, infrastructure and business process services and
scope for premium pricing in strategic IT work. Vendors are trying to combat
commoditization by efficiency gains through re-use of code, greater usage of
tools and broadening the employee pyramid.
�� Year of M&A, globalization: Expansion initiatives into new geographies
(Europe, Latin America, APAC), services (IMS) and new business models
leveraging products, platforms and cloud, could drive M&A for cash rich Tier-1
vendors. In 2012, we could also see acceleration in growth of employee base
outside India as emerging markets and consulting grow as a proportion of
revenue and visa approvals remain difficult. Investment in such new growth
avenues could pressure margins.
Top Buys: TCS, Hexaware, HCLT
Top stock pick: TCS
�� TCS: We forecast an 18% EPS CAGR over FY12-14 and expect valuation
premium over peer Infy to sustain on: (1) all-round favorable demand momentum
along with a stable management team, (2) highest exposure to the fast growing
emerging markets and (3) market-share gains in infrastructure management
services. Our PO of Rs1,260 is based on 20x FY13E earnings.
�� Hexaware: Revenue visibility for CY12E remains strong given the large deal
wins (USD600mn worth) over last 15 months. We believe margin expansion is
sustainable and likely to surprise on the upside. The stock trades at 10x CY12E.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
IT services (Mitali Ghosh, Pratish Krishnan, Kunal Tayal)
Neutral
Key drivers of sector outlook
�� Demand holding up amid increased macro risks: Despite a spate of cuts to
2012 GDP forecasts, on-ground checks reveal that demand for Indian offshore
vendors remains intact given an environment of slow growth and tight budgets is
propelling use of services by offshore vendors.
�� Consensus EPS estimates likely to see upward revisions driven by the steep 7%
INR-US$ depreciation exchange rate even in the last one month. We estimate
EPS sensitivity for top-four vendors as 1.2-3% for every 1% change, on an unhedged
basis.
�� Among the services, we expect growth for vendors to be led by run-thebusiness
services (non-discretionary), especially infrastructure management
services (IMS). Growth for IMS is likely to be driven by market-share gain for
Indian vendors, helped by a large pipeline of legacy deals, currently with western
SIs, coming up for renewal.
�� Given an uncertain macro climate and likely quarterly review of IT budgets in
2012, discretionary spends (services like application development and
package implementation) may see slower growth. However, unlike 2008,
discretionary IT demand has not dried up and is being driven by spends on
regulation, business optimization including adoption of technologies like cloud
and analytics and business transformation to address an increasingly digital
consumer and employee, globalization and growing ‘mobility’.
�� Pricing: We see twin trends of commoditization of “run-the-business” activities
of application maintenance, infrastructure and business process services and
scope for premium pricing in strategic IT work. Vendors are trying to combat
commoditization by efficiency gains through re-use of code, greater usage of
tools and broadening the employee pyramid.
�� Year of M&A, globalization: Expansion initiatives into new geographies
(Europe, Latin America, APAC), services (IMS) and new business models
leveraging products, platforms and cloud, could drive M&A for cash rich Tier-1
vendors. In 2012, we could also see acceleration in growth of employee base
outside India as emerging markets and consulting grow as a proportion of
revenue and visa approvals remain difficult. Investment in such new growth
avenues could pressure margins.
Top Buys: TCS, Hexaware, HCLT
Top stock pick: TCS
�� TCS: We forecast an 18% EPS CAGR over FY12-14 and expect valuation
premium over peer Infy to sustain on: (1) all-round favorable demand momentum
along with a stable management team, (2) highest exposure to the fast growing
emerging markets and (3) market-share gains in infrastructure management
services. Our PO of Rs1,260 is based on 20x FY13E earnings.
�� Hexaware: Revenue visibility for CY12E remains strong given the large deal
wins (USD600mn worth) over last 15 months. We believe margin expansion is
sustainable and likely to surprise on the upside. The stock trades at 10x CY12E.
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