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India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
New verticals, EMEA to lift Indian IT biggies’ prospects to ~15% CAGR
While the worldwide IT spend is expected to post a three-year CAGR of 3.9%, we believe Indian IT biggies (Cognizant, TCS, Infosys, Wipro and HCL Tech) will post a 15% CAGR over FY12-15E. This growth will be driven by market share gains and new requirements in matured segments like BFSI and manufacturing as well as higher growth from upcoming verticals like retail, healthcare, utilities and travel where despite a relatively smaller base (~USD286bn vs ~USD724bn in matured verticals), a swift adoption of technology is pushing growth. We expect worsening macros, cost cutting initiatives and demand for robust systems to drive growth in large markets like EMEA, where inspite of huge opportunities the penetration levels have remained low.
Sufficient margin levers to offset incremental costs
Interestingly, we observe that despite a wage hike of 8-10% every year, margins of large IT players have not declined in the same proportion. While we acknowledge an inevitable and gradual decline in margins, our analysis of cost triggers and margin levers clearly highlights how incremental costs like wage hikes, visa rejections and sub-contracting can be swiftly absorbed by pyramid rationalisation, higher proportion of offshore execution, improvement in utilisation levels and non-linear businesses.
Innovative trends to keep margins buoyant
Even amidst the saga of a radical shift in market share, pricing gaps with MNCs have been narrowing consistently, limiting churns and retaining renewals. In our view, it will be ideal for the Indian offshore sector to move commoditised products to Tier II cities within India to address manpower issues like high salaries and higher attrition and to sustain their price arbitrage for a longer period. Secondly, despite all the clamour and protectionist measures, offshoring has not dipped; primary reason being lack of technical resources in protectionist geographies, however, as the bottom of the pyramid gets commoditised, it can also meet with fate similar to BPO, where both growth and margins can be under pressure. We believe that larger players like Infosys and TCS had been able to foresee the above change in business model and had quickly adopted the same. Both Infosys and TCS have not only shifted delivery centers to Tier II cities but also had started delivering the low end solutions through platforms which will enable growth and margins to sustain. Although, we admit a pure product or a platform-based growth will also entail a high risk of failure, we believe calculated risk of de-linking revenues from headcount on a gradual basis is the need of the hour and should be the strategy going forward. We like TCS and Infosys for their pro-active stance on this aspect.
P/E multiples: Alignment of Indian players with MNCs seems unfair
Over the past five- six years, one-year forward P/E bands of Indian companies have dipped from 25x to 18x, implying a decline of ~28%, which to an extent is justified due to diminishing growth rates. We have also seen an alignment of P/E bands of MNCs and Indian players with the deceleration of growth for Indian IT players, which in our view is unfair given the continued low growth rates and margins of the MNC’s. We believe the above alignment is temporary in nature and will reverse once growth comes back and Indian corporates deploy their huge cash balances for acquisitions or buy backs in line with their MNC counterparts.
Valuation and outlook: Pecking order based on ranks
While we admit that there can be some challenges in near term due to financial turmoil and globaluncertainties, we continue to maintain our positive stance on the offshoring model based on current penetration levels (~11%), significant labour arbitrage and lack of technical expertise in the demand market. We also believe that new geographies like EMEA and new verticals like energy, retail and healthcare will be the key drivers of growth in coming years. Inspite of our positive stance on growth and margins, we believe that TCS is fairly valued at 17x our FY14E EPS of INR75, and provides limited upsidefrom the current level. From an upside perspective, we believe Infosys is currently attractive at 12.4x FY14E EPS of INR192 as we value the stock at 15x our FY14E, leaving it with a comfortable upside of 21%. For Wipro, we believe that Mr. Kurien has to deliver higher growth and pull margins back to earlier levels to get a higher multiple. We value it at 15x FY14E EPS of INR29.5, which leaves Wipro with a 13% upside from the current level even as we maintain a ‘HOLD’ recommendation. For HCL, the key risk is to maintain margins, though it has done a commendable job by winning deals worth almost USD2.5bn in the past two quarters. Currently, we assign 13x to FY14E earnings of INR41, implying a target price of INR527, which creates a potential upside of 9%. We maintain our ‘HOLD’ recommendation.
We prefer Infosys; wait for better entry points in TCS, HCLT and Wipro
We recommend investors to wait for better entry points in TCS, Wipro and HCL Technologies while BUY Infosys at current levels. We would recommend TCS at INR1,100 levels, Wipro at INR380 levels and HCL Tech at INR450 levels to get a meaningful upside.
Regards,
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