CTSH 3Q10 Results – Implications for Indian IT Services:: Citi

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Indian IT Services
CTSH 3Q10 Results – Implications for Indian IT Services

 Q3 results in line with peers — CTSH's revenues grew ~10% qoq, in line with
large Indian peers TCS/Infosys (they reported ~10-12% qoq). However, this comes
on the back of a very strong Q2 where CTSH delivered ~15% qoq – much higher
than the Indian top-tier. The guidance for Q4 of "at least" 4.4% qoq growth was
again largely in line with what Infosys/Wipro have guided for (3.5-5.5% qoq).


 Cautious commentary — Management commentary was cautious despite the
strong quarter. The strong performance in Q3 was attributed to the tail end of pent
up demand post two years of weak demand. Management does not anticipate a
budget flush in Q4 and believes that the M&A spends will stop growing. However,
it could be more of expectation management, given high expectations following
the scale of beat in the last couple of quarters.

 2011 IT budgets — Management indicated that it was too early to have clarity on
CY11 budgets, however: (1) the budgeting cycle this year seems to be normal, (2)
early feedback suggests some uptick in IT budgets next year, and (3) the trend of
outsourcing/offshoring gaining share is expected to continue. Our 3Q10 Citi CIO
survey, released today, points to 1.4% yoy growth in IT Budgets
(https://www.citigroupgeo.com/pdf/SNA66181.pdf).

 Key highlights from the call — (1) Application development at 14% qoq grew
faster than maintenance (6% qoq). (2) Retail, Manufacturing & Logistics grew
~13% qoq while BFSI at ~11% qoq, grew ahead of company. (3) Europe grew
faster at ~15% qoq. (4) Onsite pricing was up ~1% qoq; offshore pricing was
flattish. (5) Company had strong lateral hiring with 47% of the ~12k gross adds
(~7k net adds) – indicates near-term visibility. (6) Attrition at 21.8% (quarterly
annualized) increased ~110bps qoq – a trend witnessed across the industry. (7)
Except a few pockets, supply of talent is not a big issue, as per management.

 Sector view – Neutral — Moderate growth in IT budgets with increased offshoring
should drive decent growth for the Indian IT Industry. We believe consensus is
already pricing that in with ~20-25% yoy revenue growth expectations for FY12.
Supply side/currency related pressures remain – we remain Neutral.

 Our thoughts on Tier I stocks — We continue to like HCLT (1L) – improvement in
margins/cashflows in coming quarters should be a catalyst given reasonable
valuations. Wipro (1L) needs to deliver a strong quarter for rerating; could be
range bound in the near term. Infosys (2L) could be a good defensive given ~15%
underperformance vs Sensex (last 3m) but difficult to see meaningful absolute
upside. TCS (2L) has delivered but priced in – we would book partial profits.