In our view, HCL Tech and TCS will be the main beneficiaries of the recent
rupee depreciation. Our sensitivity analysis suggests that, ceteris paribus, for
every 1% depreciation of the INR vs. the USD, earnings of the top-tier Indian IT
service companies are likely to increase by 1.5-1.9%, while EBIT margins will
be up 20-25bps in FY14E. We believe HCL Tech and Infosys are the most likely
to post better-than-expected margin performance if the rupee weakness
persists, while TCS will reinvest the gains from the weaker rupee to improve its
top line. We reiterate our positive view on the sector, with TCS and Tech
Mahindra our top picks.
Prolonged rupee weakness could accelerate turnaround at Infosys
Rupee depreciation further improves the competitiveness of the Indian IT
service companies. In particular, it will enable vendors to enhance win rates in
IMS (infrastructure management services) based deals. Margin pressure
exerted by these deals (which, in some cases, involve transfer of assets and
employees) can be offset by gains from a weaker rupee. In keeping with recent
trends, we believe TCS will use the current rupee weakness to win more
transformational engagements (involving IMS) and improve its top line, while
maintaining operating margins. With regard to Infosys, a weaker rupee can
help accelerate the ‘course correction’ undertaken by the company. In the
short term, however, we expect it to partially offset the impact of (a) pricing
pressure, (b) wage increases, (c) the deferred cost of the Lodestone acquisition
and (d) heightened investment in sales.
Weak rupee to improve operating margins by 100-150bps in the June-Q
In the June-Q, the rupee has depreciated 5% (average for the quarter) vs. the
USD. We believe this will likely improve operating margins (EBIT) positively by
100-150bps. For TCS, wage hikes offered during the quarter will affect
operating margins by 200-250bps qoq. Overall, we expect TCS to deliver a
25.5% (-100bps qoq) EBIT margin during the Jun-Q.
Valuing Indian IT service stocks at PE of 13-20x FY14E earnings; risks
We continue to value the stocks at 13-20x one-year forward earnings (relative
to their historical trading range, comparing with peers, as well as growth rates)
and will revisit our earnings estimates and target PE multiples once there is
more clarity on the nature and size of IT budgets and the sustainability of the
demand pick-up. The key sector risks relate to cross-currency headwinds.
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rupee depreciation. Our sensitivity analysis suggests that, ceteris paribus, for
every 1% depreciation of the INR vs. the USD, earnings of the top-tier Indian IT
service companies are likely to increase by 1.5-1.9%, while EBIT margins will
be up 20-25bps in FY14E. We believe HCL Tech and Infosys are the most likely
to post better-than-expected margin performance if the rupee weakness
persists, while TCS will reinvest the gains from the weaker rupee to improve its
top line. We reiterate our positive view on the sector, with TCS and Tech
Mahindra our top picks.
Prolonged rupee weakness could accelerate turnaround at Infosys
Rupee depreciation further improves the competitiveness of the Indian IT
service companies. In particular, it will enable vendors to enhance win rates in
IMS (infrastructure management services) based deals. Margin pressure
exerted by these deals (which, in some cases, involve transfer of assets and
employees) can be offset by gains from a weaker rupee. In keeping with recent
trends, we believe TCS will use the current rupee weakness to win more
transformational engagements (involving IMS) and improve its top line, while
maintaining operating margins. With regard to Infosys, a weaker rupee can
help accelerate the ‘course correction’ undertaken by the company. In the
short term, however, we expect it to partially offset the impact of (a) pricing
pressure, (b) wage increases, (c) the deferred cost of the Lodestone acquisition
and (d) heightened investment in sales.
Weak rupee to improve operating margins by 100-150bps in the June-Q
In the June-Q, the rupee has depreciated 5% (average for the quarter) vs. the
USD. We believe this will likely improve operating margins (EBIT) positively by
100-150bps. For TCS, wage hikes offered during the quarter will affect
operating margins by 200-250bps qoq. Overall, we expect TCS to deliver a
25.5% (-100bps qoq) EBIT margin during the Jun-Q.
Valuing Indian IT service stocks at PE of 13-20x FY14E earnings; risks
We continue to value the stocks at 13-20x one-year forward earnings (relative
to their historical trading range, comparing with peers, as well as growth rates)
and will revisit our earnings estimates and target PE multiples once there is
more clarity on the nature and size of IT budgets and the sustainability of the
demand pick-up. The key sector risks relate to cross-currency headwinds.
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