Infy, Tech Mahindra/Satyam up to Buy, ~25% pot. upside
We lift POs across our IT services coverage for 18-28% potential stock upside in
our Buy rated large caps. Key drivers: a) Earnings upgrades of up to 7% in
FY14/15, led by improved revenue confidence b) consequent re-rating of our
stocks by 7-8% and c) roll-forward of earnings by six months. We upgrade Infosys
and Tech Mahindra (on pro-forma combined financials including Satyam) to Buy
on early signs of success in addressing company-specific challenges. In our view,
Infy could surprise in Sept or Dec. quarter, TCS will likely report strong but largely
discounted results and Wipro could disappoint on quarter/guidance.
Demand environment looks up
Anecdotal evidence indicates that deal closures are picking up and softness in the
banking vertical is bottoming. This is likely due to increased confidence on
business outlook post the recent easing measures by central banks, in our view.
Not only are we seeing continued focus on optimization of the tech landscape, but
we are also hearing of a sustained pick-up in transformational deals. These deals
aim to – a) use technology to transform business models (eg, online retailing) and
processes (digital marketing, mobility banking, analytics) and b) transform the
client’s tech landscape by leveraging cloud, social media etc. Steady realization.
Upgrading Infosys to Buy; Potential 25% stock upside
Post 20% YTD underperformance vs Sensex, we upgrade INFY to Buy with a PO
of Rs3,200 on – a) 6-7% earnings upgrades in FY14/15 b) re-rating the stock from
a target of 14x 1yr forward PE to 16x, narrowing the discount vs. TCS to 10%.
INFY seems to be course-correcting its response in the commoditized application
& IT infrastructure maintenance (IMS) business, where it was losing share, by
exploring alternate delivery models. Also, with greater empowerment to the field
and transformation in sales, we anticipate improved customer responsiveness and
mining. Most importantly, with the organization restructuring well under way,
management seems to be more settled and in execution mode, as reflected in
initiatives taken to address IMS/apps maintenance and the Lodestone acquisition.
Tech Mahindra, Satyam up to Buy; >25% potential upside
We reset our estimates and raise Tech M to Buy, with a PO of Rs1,150, given our
forecast healthy 15% EPS CAGR over FY12-15 for the combined entity (final
merger approval expected by year end). Increasing traction in managed services
deals in Europe and Emerging Markets, an area of strength for TechM, increases
our confidence in rev outlook. Satyam’s rev traction is led by client mining and
increased deal participation rates. Moreover, improving scale, productivity and mix
lend margin support. At 10xFY14e combined financials, stock is attractively
valued and increasing revenue visibility, scale and liquidity should help re rate to
12x 1-yr forward. Satyam’s PO of Rs135 is based on announced swap ratio of 8.5
s hares for 1 share of Tech M. We are 5% ahead on FY14 consensus EPS.
Infosys and Tech Mahindra up to Buy
We lift POs across our IT services coverage for 13-25% potential stock upside on
the back of:
a) Earnings upgrade of up to 7% in FY14/15, led by improved revenue visibility as
decision making and deal closures seem to be on an uptrend and the worst in the
banking vertical seems to be behind us.
b) Consequently, we have re-rated our target PEs by 7-8%.
c) We have rolled-forward earnings by six months. Our one-year price objectives
are now based on earnings for the 12-months ending Sep ’14, vs. Mar ‘14 earlier.
Further, we upgrade Infosys and Tech Mahindra (on proforma combined basis
including Satyam) to Buy on early signs of success in addressing companyspecific
challenges.
Demand environment looks up
Anecdotal evidence suggests pick-up in deal closures
Anecdotal evidence indicates that deal closures are showing signs of pick-up and
softness in the banking vertical appears to be bottoming. We believe this is due to
increased confidence on business outlook post the recent easing measures taken
by the central banks, as below.
While the cycle may take time to pick up and discretionary IT spend may take at
least a couple of quarters to pick up, we hear of not only a continued focus to
optimize the tech landscape, but also a sustained pick-up in transformational
deals to address the structural challenges customers face. These deals aim to –
a) use technology to transform business models (e.g. online retailing) and
processes (digital marketing, mobility banking, analytics) and b) transform the
client’s tech landscape by leveraging cloud, social media etc.
Decision cycles could improve post QE3, US elections
During CY12, the biggest constraint on revenue growth for vendors, in our view,
has not been the lack of IT budgets but the push-out of decisions by clients. This
has been on account of (1) economic uncertainty hampering business confidence
and (2) a cautious view going into the US Presidential election season.
Post a series of easing measures announced by the ECB and US Fed last week,
we would expect an improvement in decision cycles for vendors. The completion
of the US presidential elections in November should also likely help speed up
decision cycles, given likely clarity in policy direction.
The Fed raised the upper end of its forecast for US GDP growth to 3.0% (CY13)
and 3.8% (CY14) vs. 2.8% / 3.5% earlier. It also expects the US unemployment
rate to drop below 8% by end-2013.
Our US economist, Ethan Harris, forecasts a more modest growth of 2.1% (for
CY13) and 1.4% (CY14).
While recovery may be protracted, the confidence lent by dovish signals from
central banks is likely to soothe nerves and improve decision making, as above.
See limited risk of sharp Rupee appreciation
Post easing measures announced by US Fed last week, Rupee has appreciated
3% from ~55.4 to 54.0. We factor in Rupee appreciation in our model to an
average INR-USD rate of 54.2 for FY13 going to Rs53.0 (2% appreciation) for
FY14 and further to Rs51 (3.8% appreciation) for FY15.
Our economist, however, does not expect a sharp appreciation in the Rupee
given his view that:
RBI needs to recoup US$50bn sold since 2008
Typically, RBI has weakened INR to support growth in downturns
Infosys – raise to Buy with PO of Rs3,200
As in our detailed note on INFY published simultaneously today (Upgrade to
Buy), we raise INFY to Buy with a PO of Rs3,200 (vs Rs2,450 earlier) on a) 6-7%
revenue led earnings upgrade in FY14/15 and b) rerating of the stock from a
target PE of 14x 1yr forward to 16x, narrowing the PE discount vs TCS to 10%.
Our interactions with senior management including the CEO and channel checks
give us comfort that management is taking action to remedy gaps in the services
portfolio, selling effort and execution, and this is starting to yield results.
Moreover, Infy is likely to be a key beneficiary of any pick-up in discretionary IT
spend as business confidence picks up, post measures taken by the Fed/ECB.
We expect in-line 2Q results and commentary on improving business traction to
be a trigger.
INFY seems to be course-correcting its response in the commoditized application
& IT infrastructure maintenance business, where it was losing share, by exploring
alternate delivery models. Also, with greater empowerment to the field and
transformation in sales, we anticipate improved customer responsiveness and
mining. Most importantly, with the organization restructuring well under way,
management seems to be more settled and in execution mode, as reflected in
initiatives to address the IT infra market and the Lodestone acquisition.
Tech Mahindra / Satyam – Up to Buy with PO of
Rs1,150 / Rs135
As in our upgrade note today, we reset our estimates and raise Tech Mahindra
(on proforma combined financials including Satyam) to Buy given our forecast of
healthy 15% EPS CAGR over FY12-15 for the combined entity. Increasing
traction in managed services deals in Europe and emerging markets, an area of
strength for TechM, increases our confidence in revenue outlook. Meanwhile,
client mining and increased deal participation rates in the past two years are
driving Satyam’s revenues. Moreover, improving scale, productivity and mix
should lend margin support too.
At 10xFY14E combined financials, the Tech M stock is attractively valued and
with increasing revenue visibility, scale and liquidity post merger, can re-rate to
12x 1-yr fwd, by our estimates. Satyam’s fair value works out to Rs135 by
applying announced swap ratio (2:17) on our PO of Rs 1,150 for Tech M. Our
EPS estimate for the combined entity is about 5% ahead on FY14 consensus.
TCS - retain Buy, raise PO to Rs1,575
We retain our Buy on TCS and raise PO to Rs1,575 (18x 1yr roll forward PE),
derived from a 5yr PEG of 1.1x. The stock is currently trading at 19x FY13E.
Channel checks and management meetings indicate that TCS continues to see
strong deal traction, as highlighted in our last note (Management meet takeaways).
TCS’ large deal closures remain steady helped by its broad market
presence across service lines and geographies. Strong client relationships,
rapidly growing brand power and agility in the market are helping it gain market
share.
While we do see margin levers from the INR, operational levers like utilization and
improving profitability in emerging markets like Latam and in platforms, we also
believe TCS is keen to maintain broadly stable margins (as we have modeled in),
and reinvest gains in building new medium-term revenue drivers, specially
products & platforms.
HCL Tech – retain Buy, raise PO to Rs675
We retain our Buy on HCL Tech and raise PO to Rs675, at a target PE of 13x 1-
yr forward PE, at a 5-yr PEG of 0.8. The stock is currently at 13x FY13E. Our
thesis on HCLT remains unchanged i.e. that of high revenue visibility with
possible upside risk to margins.
We believe HCLT’s impressive deal wins in Dec. and Mar quarter are ramping on
track, with growth led by both its dominance in IT Infrastructure Management
Services and increasing market share in the discretionary enterprise solutions
business.
While margins beat our expectations last quarter helped by a115bp contribution
from productivity improvements, we continue to assume that the bulk of these
gains will be reinvested in the business in the form of wage hikes and building IP.
Key risk to our rating is higher than expected transition costs or any cost over
runs in outsourcing deals hitting margins.
Wipro - retain Neutral, raise PO to Rs420
We raise our PO on Wipro to Rs420, at a target 5yr PEG of 1.1x implying a 1yr
rolling forward PE of 14x. Stock currently at 14.5X FY13 PE.
While Wipro’s client mining efforts have been paying off, hunting efforts are likely
to take at least 3-4 quarters more to deliver, in our view, given the company has
seen a fair amount of reorganization and churn in senior and mid levels over the
last couple of years and increased competition.
That said, we have heard of a few large deal wins in healthcare and oil and gas.
We also hear that they are chasing some large deals in the banking space. While
large deal closures may provide a short-term trigger for the stock, we remain
cautious on a sustained pick-up.
They continue to see challenges in the telecom equipment, investment banking
and retail verticals.
We expect muted revenue growth both this quarter and next quarter, based on
the weak hiring trends in recent quarters.
2Q preview – Commentary likely to be positive
Infy could surprise; Wipro could disappoint
• We expect the large Indian IT stocks to report largely in-line results with
cautiously optimistic commentary on pick-up in deal closures.
o If Infosys seems some of the delayed ramp ups in previous quarters
come through, it could surprise on volumes, either this quarter or
next.
o TCS will likely report strong but in line volumes
o Wipro could disappoint on volumes/guidance in our view
• For TCS and Infosys, we expect margins to be steady sequentially, given the
currency and pricing are broadly steady.
• Wipro will have the impact of two months of the annual wage hike announced
last quarter and HCL Tech, Satyam and Tech M will also have their wage
hike this quarter.
• Tech M’s revenue growth is driven by the inorganic addition of Hutch Global
Services. We expect margins to be hit not only by the wage hike but also the
lower profitability of HGS at perhaps 10-15% operating margins and by
transition costs of recent deal wins.
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