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Indian IT company reverse road-trip wrapup
Companies remain optimistic of continued industry growth
In our view, growth from key demand markets is likely to be
more cyclical going forward as offshore penetration in
traditional IT services is high now
Companies who are continuously diversifying, thereby
expanding their addressable market should outperform; OWrated
TCS is our preferred play
Demand commentaries are positive for 2012
We met with the management of 11 top Indian IT companies* last week to analyse the
demand environment and expectations for 2012 and beyond. Most of the companies remain
reasonably positive on the 2012 growth prospects. Demand for 1Q2012 looks weak as
clients are involved in the budgeting process and cautious of the macro environment, but the
"hopium" levels for 2H revival are high.
However, the contours of growth are likely to change, in our view
Long-term growth, we believe, will be a mix of both secular offshoring and fresh IT
spending by clients. Revenue growth from mature geographies/vertical markets, such as
BFSI (banking, financial services and insurance) in US would increasingly be dependent on
the absolute spend (growth or decline) by banks, thereby making it more cyclical. We found
similar sentiments for markets such as Retail in US/Europe. Revenues for Indian companies
from Retail clients is currently driven by both new growth initiatives by retailers and cost
cutting initiatives. Near 50% of growth (from retail industry) is already driven by initiatives
such as digital marketing, customer data analytics etc, which are revenue enhancing for
clients and not just targeting cost cutting.
Consequently, we believe growth would be highly contingent on IT budget growth, making
it more cyclical and market share led growth would continue to moderate. We highlighted
our expectation of similar trends in our 8 February 2012 report, "Diversity in Adversity”.
However, it is worth highlighting again that in this moderating growth scenario, companies
that are able to increase their addressable market (as TCS did with pension procession and
core banking BPO) should be able to outperform competition.
* We met TCS CFO- Mr. S Mahalingam and Head IR- Mr. Kedar Shirali); Infosys Member
of Executive Council and Head of Retail and CPG- Mr. Pravin Rao; Wipro IT services
CFO- Mr. Jatin Dalal and Co-head IR- Mr. Aravind V; HCLT CFO- Mr. Anil Chanana;
Mindtree CEO Mr. Krishnakumar Natarajan; Hexaware CSO- Mr. Sreenivas V;
MahindraSatyam CMO & CPO- Mr. Hari Thalapalli; Mphasis CFO- Mr. Ganesh Murthy;
Persistent Systems CFO- Mr. Rajesh Ghonasgi; eClerx CFO- Mr. Rohitash Gupta; Infinite
Computers CEO- Mr. Upinder Zutshi)
Indian IT company reverse road-trip - Key highlights:
Big or mid all are moving up the "Vertical" ladder
The IT services industry in India is can largely be categorised into two groups of companies (Large cap
and Mid cap). Large companies such as TCS and Infosys are significantly larger than the mid-cap
companies such as Mindtree, Hexaware etc. However, across these groups of companies the clear focus
on vertical markets was noteworthy. Larger companies have totally aligned their organisations to the
vertical structure and smaller companies have shortlisted on the specialised verticals that they focus on for
their go-to-market strategy.
While the vertical focus undoubtedly seems to be the right strategy at this stage (as companies are able to
offer more domain-centric solution to clients and also improve account management), with all the
companies diverting to this common path, it is hard to envisage any compelling competitive advantage for
any company, of course other than scale advantage. We still believe that companies with most diversified
client base, revenue profile, and growth strategy will continue to lead the market in the long term.
Client mining – the key focus area for all
Another clear focus area for all the companies was client mining and the stress on client
relationship/account management to increase the wallet size. Here again, while Wipro has shown a
significant improvement in terms of client wallet share metrics (in the past few years), any prediction of
this trend to continue would be tough to make as every company outlined a similar strategy/desire to
growth (refer chart sheet on page 3).
Non-linear growth:
Focus on non-linear growth (use of reusable tools, platforming, solutioning) was ubiquitous across all
companies. There are specific solutions and platforms every company has across various demand
markets, but there is no convincing clear winner in any category.
Visa risks:
Across the board, the companies agreed on the increase in visa rejections, particularly the L1 visas.
However, most of them believed it is still not impacting their business as they already have reasonable
number of employees with visas to take care of the onsite deliverables. Wherever required, the companies
are hiring onsite (permanent employees or sub-contractors) as well. While this is not margin-dilutive in
the near term, a continued trend would impact the organizational flexibility in terms of managing onsite
utilization and offshore rotation of employees. TCS has consciously increased its proportion of H1 visas.
Historically, the company has relied more on L1 visas for travel requirements.
Growth vs profitability
At this stage, most of the companies were only concerned/involved in capturing growth opportunities.
None of the companies/management were worried about margin pressure or wage inflation. It is near
certain that wage inflation in 2012 is likely to be in single-digits and companies across the board have
planned increase in campus hiring, thereby flattening the employee pyramid. It will be interesting to see if
the expected acceleration in growth in 2H2012 would increase supply pressure. As of now, the industry
sure seems to be weighted in favour of the employers.
Valuation and risks
TCS (TCS.BO; INR1,220, Overweight; TP INR1,365)
TCS is currently trading at nearly 20x FY13e EPS. We believe it will continue to trade at this valuation
level. We value the company at 20x our December 2013 annualised earnings, with a target price of
INR1,365 and remain Overweight.
Under our research model, for stocks without a volatility indicator, the Neutral band is 5 percentage
points above and below the hurdle rate for India stocks of 11%. At the time we set our target price, it
implied a potential return that was above the Neutral band; therefore, we rate the stock Overweight.
Potential return equals the percentage difference between the current share price and the target price,
including the forecast dividend yield when indicated.
Risks
1) Deterioration in macroeconomic conditions is a primary risk which may result in a delay in decision
making and, therefore, project ramp-ups. 2) The appreciation of the rupee against the US dollar is one of the
key risks to our estimates. While management is confident of maintaining an EBIT margin of around 27%
even if the rupee appreciates to 46, any appreciation in the rupee will impact sentiment and stock valuation.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Indian IT company reverse road-trip wrapup
Companies remain optimistic of continued industry growth
In our view, growth from key demand markets is likely to be
more cyclical going forward as offshore penetration in
traditional IT services is high now
Companies who are continuously diversifying, thereby
expanding their addressable market should outperform; OWrated
TCS is our preferred play
Demand commentaries are positive for 2012
We met with the management of 11 top Indian IT companies* last week to analyse the
demand environment and expectations for 2012 and beyond. Most of the companies remain
reasonably positive on the 2012 growth prospects. Demand for 1Q2012 looks weak as
clients are involved in the budgeting process and cautious of the macro environment, but the
"hopium" levels for 2H revival are high.
However, the contours of growth are likely to change, in our view
Long-term growth, we believe, will be a mix of both secular offshoring and fresh IT
spending by clients. Revenue growth from mature geographies/vertical markets, such as
BFSI (banking, financial services and insurance) in US would increasingly be dependent on
the absolute spend (growth or decline) by banks, thereby making it more cyclical. We found
similar sentiments for markets such as Retail in US/Europe. Revenues for Indian companies
from Retail clients is currently driven by both new growth initiatives by retailers and cost
cutting initiatives. Near 50% of growth (from retail industry) is already driven by initiatives
such as digital marketing, customer data analytics etc, which are revenue enhancing for
clients and not just targeting cost cutting.
Consequently, we believe growth would be highly contingent on IT budget growth, making
it more cyclical and market share led growth would continue to moderate. We highlighted
our expectation of similar trends in our 8 February 2012 report, "Diversity in Adversity”.
However, it is worth highlighting again that in this moderating growth scenario, companies
that are able to increase their addressable market (as TCS did with pension procession and
core banking BPO) should be able to outperform competition.
* We met TCS CFO- Mr. S Mahalingam and Head IR- Mr. Kedar Shirali); Infosys Member
of Executive Council and Head of Retail and CPG- Mr. Pravin Rao; Wipro IT services
CFO- Mr. Jatin Dalal and Co-head IR- Mr. Aravind V; HCLT CFO- Mr. Anil Chanana;
Mindtree CEO Mr. Krishnakumar Natarajan; Hexaware CSO- Mr. Sreenivas V;
MahindraSatyam CMO & CPO- Mr. Hari Thalapalli; Mphasis CFO- Mr. Ganesh Murthy;
Persistent Systems CFO- Mr. Rajesh Ghonasgi; eClerx CFO- Mr. Rohitash Gupta; Infinite
Computers CEO- Mr. Upinder Zutshi)
Indian IT company reverse road-trip - Key highlights:
Big or mid all are moving up the "Vertical" ladder
The IT services industry in India is can largely be categorised into two groups of companies (Large cap
and Mid cap). Large companies such as TCS and Infosys are significantly larger than the mid-cap
companies such as Mindtree, Hexaware etc. However, across these groups of companies the clear focus
on vertical markets was noteworthy. Larger companies have totally aligned their organisations to the
vertical structure and smaller companies have shortlisted on the specialised verticals that they focus on for
their go-to-market strategy.
While the vertical focus undoubtedly seems to be the right strategy at this stage (as companies are able to
offer more domain-centric solution to clients and also improve account management), with all the
companies diverting to this common path, it is hard to envisage any compelling competitive advantage for
any company, of course other than scale advantage. We still believe that companies with most diversified
client base, revenue profile, and growth strategy will continue to lead the market in the long term.
Client mining – the key focus area for all
Another clear focus area for all the companies was client mining and the stress on client
relationship/account management to increase the wallet size. Here again, while Wipro has shown a
significant improvement in terms of client wallet share metrics (in the past few years), any prediction of
this trend to continue would be tough to make as every company outlined a similar strategy/desire to
growth (refer chart sheet on page 3).
Non-linear growth:
Focus on non-linear growth (use of reusable tools, platforming, solutioning) was ubiquitous across all
companies. There are specific solutions and platforms every company has across various demand
markets, but there is no convincing clear winner in any category.
Visa risks:
Across the board, the companies agreed on the increase in visa rejections, particularly the L1 visas.
However, most of them believed it is still not impacting their business as they already have reasonable
number of employees with visas to take care of the onsite deliverables. Wherever required, the companies
are hiring onsite (permanent employees or sub-contractors) as well. While this is not margin-dilutive in
the near term, a continued trend would impact the organizational flexibility in terms of managing onsite
utilization and offshore rotation of employees. TCS has consciously increased its proportion of H1 visas.
Historically, the company has relied more on L1 visas for travel requirements.
Growth vs profitability
At this stage, most of the companies were only concerned/involved in capturing growth opportunities.
None of the companies/management were worried about margin pressure or wage inflation. It is near
certain that wage inflation in 2012 is likely to be in single-digits and companies across the board have
planned increase in campus hiring, thereby flattening the employee pyramid. It will be interesting to see if
the expected acceleration in growth in 2H2012 would increase supply pressure. As of now, the industry
sure seems to be weighted in favour of the employers.
Valuation and risks
TCS (TCS.BO; INR1,220, Overweight; TP INR1,365)
TCS is currently trading at nearly 20x FY13e EPS. We believe it will continue to trade at this valuation
level. We value the company at 20x our December 2013 annualised earnings, with a target price of
INR1,365 and remain Overweight.
Under our research model, for stocks without a volatility indicator, the Neutral band is 5 percentage
points above and below the hurdle rate for India stocks of 11%. At the time we set our target price, it
implied a potential return that was above the Neutral band; therefore, we rate the stock Overweight.
Potential return equals the percentage difference between the current share price and the target price,
including the forecast dividend yield when indicated.
Risks
1) Deterioration in macroeconomic conditions is a primary risk which may result in a delay in decision
making and, therefore, project ramp-ups. 2) The appreciation of the rupee against the US dollar is one of the
key risks to our estimates. While management is confident of maintaining an EBIT margin of around 27%
even if the rupee appreciates to 46, any appreciation in the rupee will impact sentiment and stock valuation.
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