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Forecast 24% revenue growth amid macro concerns; Buy INFY, HCL
Large caps to sustain outperformance; INFY and HCL are top picks
Large-cap IT firms have outperformed mid-cap peers and BSE Sensex ytd
(by 4% and 21%). However, concerns over growth sustenance and resultant
valuations have cropped up amid global macro concerns. With our channel
checks pointing to a stable demand environment, we expect the large-caps
to sustain outperformance and we view this as an opportunity to increase
exposure to the sector. Our top picks remain HCLT and Infosys, offering
29%/23% earnings CAGR over FY11-FY13E, and 21%/22% potential upside.
Demand backdrop remains strong, ACN/ORCL results set the trend
We derive support for our stable demand environment forecast from recent
better than expected results from Accenture & Oracle. In our view, broadbased growth across most verticals including BFSI in ACN results has
allayed some concerns over the sustainability of tech spending. Mgmt
comments (esp. TCS) also suggest there are no major macro worries
resulting in weakening of demand and ramp ups are progressing smoothly.
IT spending survey reinforces macro view, 6% spend growth holds
Our US tech team maintains 6% global IT spending growth for 2011 despite
downward revisions to US/EU GDP and various macro concerns. The latest
GS IT spending survey indicates a strong 2H2011 with 89% of corporates
expecting 2H to be a normal-to-accelerated spending season and 93% of
them expecting 2011 spending growth to be the same or more than 2010.
1QFY12 revenue growth of 4.5% to set the base for FY12 (24% yoy)
We forecast sequential revenue growth of 4.5% in 1QFY12E for large-caps vs.
4.9% in 4QFY11, and expect this to set the base for our 24% revenue growth
forecast in FY12. Unbilled revenues, a leading indicator of revenue growth,
increased by 13.5% qoq in 4QFY11, pointing towards a strong quarter.
Infosys, with a 27% jump in 4Q appears best placed to surprise to the upside.
Taxes, wage hikes, visa costs to weigh upon earnings in 1Q
Companies have announced wage hikes effective from 1Q (except HCL),
which will impact EBIT margins by 100-150 bp, in our view, offset by
campus hiring and lower utilization rates. Incremental visa costs will also
impact margins, however channel checks show cos. have slowed visa
applications. With the end of STPI tax deductions from FY12, tax rates for
the sector are set to increase by 320 bp qoq with the exception of Infosys.
US IT Spending Indices snap back sharply, signal no slowdown
Indices at record levels, maintain 2011 IT spending growth at 6%
Conducted in mid-May, the latest Goldman Sachs IT spending survey regained its
footing after taking a pause in our April survey, with both the tech spending and capital
spending indices back to recent record levels.
Total IT spending index rebounds: to 72.5 from 68.0 (this includes salaries, services,
depreciation, occupancy, etc.) marking the second-highest index value since 2007 and
indicates that spending expectations remain strongly in expansion territory.
Tech Capital spending index rose: sharply to 72.5 in this survey, after notching down
to 66.0 in the April survey, which is the highest level since December 2006.
Maintain global IT spending forecast: Our global tech team maintains this at 6%,
mindful of some soft spots and lower Street expectations.
Pricing index notches down, but within historical values: After increasing for two
consecutive surveys, the pricing index notched down, but remains within its normal
historical range. Pricing remains one of the potential levers for Indian companies as
they look for ways to offset rising costs and wage inflation.
2H2011 looks strong: 2H2011 spending expectations reinforce strength of the indices
with a total of 28% of our panel expecting an acceleration from seasonal IT spending
for the second half of the year, which is twice the percentage of respondents who
expected an increase in 2H2010 versus 1H2010.
2011 expectations improved: In addition, IT spending expectations for 2011 improved
from the last survey with 40% of respondents (12 ppt higher than last survey)
expecting better IT spending growth in 2011 versus 2010.
Macro data disconnect: We note that most macro data points we assess have
notched down, including GDP revisions downwards. However, these are offset by
intact corporate profit growth, pricing, normal seasonal spending, and secular IT
spending drivers.
Retain 24% revenue growth for Indian IT svcs – 2H11 looks strong
The GS IT Spending survey provides a positive read across for the Indian IT companies.
There have been concerns recently on the sustenance of overall tech spending and a
consequent slowdown in revenue growth momentum for the Indian IT companies.
However, the IT spending survey allays a large part of the concerns, with 89% of the
respondents expecting 2H2011 IT spend to progress at the normal or a higher pace. What is
more noticeable is the response that 93% of the respondents expect their organization’s
2011 IT spending growth to be the same or higher than 2010.
IT services – Discretionary spending trending positively
The GS IT Spending survey showed that budgets for discretionary IT projects that require
services from systems integrators, application developers, or other IT consulting
companies, including Indian IT companies, remain strong with an upward bias. More than
80% of respondents expect IT services budgets to remain stable with about 35% expecting
them to trend upwards.
Among the various service areas of IT services, infrastructure spend grabs the highest
share with 65% of respondents expecting increased spending in infrastructure services
over the next six months. This augurs well for HCL Technologies wherein we expect
Remote Infrastructure Management services to be one of the key drivers of our 21%
revenue growth forecast over FY11-FY13E.
1Q revenue growth to set the FY12 base; tax, wages to mute EPS
Revenue growth in 1Q should remain strong and set the base for FY12
We expect sequential revenue growth of 4.5% in 1QFY12E for the large caps vs. 4.9% in
4QFY11. In our view, the June quarter will set the base for FY2012 revenue growth for the
sector. Unbilled revenues, a leading indicator of revenue growth, increased by 13.5%
qoq last quarter (+10% for only the 2
nd
time in the last three years) and point towards a
strong quarter. Infosys, with a 27% jump in 4Q ,appears best placed to surprise on the upside.
Taxes, wage hikes, visa costs to weigh upon earnings in 1Q
Companies announced wage hikes effective from this quarter (except HCL), which will
impact EBIT margins by 100-150 bp in this quarter, offset by fresher hiring and lower
utilization rates at 71% for the sector (vs. 75% in 2QFY11).
Further, incremental visa costs will also impact margins. However, companies have
slowed down visa applications due to the increase in costs and concerns over visa usage
which will spread the incremental costs evenly over the year. (Refer to our report dtd. May
30, 2011, “Assessing industry impact on the current debate over US visas”). As of May 24,
only 12,300 petitions have been made for H-1B visas out of the 65,000 quota. Also, with the
end of STPI tax deductions with effect from April 1, 2011, tax rates for the sector will rise
by 320 bp qoq (rising to 23.3% for large caps) with the exception of INFY (at 27%)
Large caps to outperform as growth and returns favor valuations
Our bias towards large-caps supported by ytd outperformance
Large cap Indian IT companies have outperformed the broader market ytd (4%
outperformance vs. BSE-30) as well as mid cap companies in the sector (mid caps down
28% ytd), inline with our view at the beginning of the year that large caps will outperform
on the back of better growth visibility and scale benefits to absorb headwinds. Refer
report dtd. Jan 12, 2011, “2011: Revenue momentum accelerates; bias towards large-caps”.
However, concerns over sustainability of growth and resultant valuations have cropped up
in the last few months. We believe, this should be taken as an opportunity to increase
exposure to the sector. Indian IT remains the sector second highest within our India
coverage in terms of CROCI generation (Exhibit 17). Despite trading at a 28% premium to
MSCI India, the sector is still trading at 18X on 1-yr fwd P/E, at the lower end of its 6-year
historical trading range of 17X-21X.
Our top picks in the sector are HCL Technologies and Infosys offering 29%/23% earnings
CAGR over FY11-FY13E and 22%/21% potential upside respectively
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Forecast 24% revenue growth amid macro concerns; Buy INFY, HCL
Large caps to sustain outperformance; INFY and HCL are top picks
Large-cap IT firms have outperformed mid-cap peers and BSE Sensex ytd
(by 4% and 21%). However, concerns over growth sustenance and resultant
valuations have cropped up amid global macro concerns. With our channel
checks pointing to a stable demand environment, we expect the large-caps
to sustain outperformance and we view this as an opportunity to increase
exposure to the sector. Our top picks remain HCLT and Infosys, offering
29%/23% earnings CAGR over FY11-FY13E, and 21%/22% potential upside.
Demand backdrop remains strong, ACN/ORCL results set the trend
We derive support for our stable demand environment forecast from recent
better than expected results from Accenture & Oracle. In our view, broadbased growth across most verticals including BFSI in ACN results has
allayed some concerns over the sustainability of tech spending. Mgmt
comments (esp. TCS) also suggest there are no major macro worries
resulting in weakening of demand and ramp ups are progressing smoothly.
IT spending survey reinforces macro view, 6% spend growth holds
Our US tech team maintains 6% global IT spending growth for 2011 despite
downward revisions to US/EU GDP and various macro concerns. The latest
GS IT spending survey indicates a strong 2H2011 with 89% of corporates
expecting 2H to be a normal-to-accelerated spending season and 93% of
them expecting 2011 spending growth to be the same or more than 2010.
1QFY12 revenue growth of 4.5% to set the base for FY12 (24% yoy)
We forecast sequential revenue growth of 4.5% in 1QFY12E for large-caps vs.
4.9% in 4QFY11, and expect this to set the base for our 24% revenue growth
forecast in FY12. Unbilled revenues, a leading indicator of revenue growth,
increased by 13.5% qoq in 4QFY11, pointing towards a strong quarter.
Infosys, with a 27% jump in 4Q appears best placed to surprise to the upside.
Taxes, wage hikes, visa costs to weigh upon earnings in 1Q
Companies have announced wage hikes effective from 1Q (except HCL),
which will impact EBIT margins by 100-150 bp, in our view, offset by
campus hiring and lower utilization rates. Incremental visa costs will also
impact margins, however channel checks show cos. have slowed visa
applications. With the end of STPI tax deductions from FY12, tax rates for
the sector are set to increase by 320 bp qoq with the exception of Infosys.
US IT Spending Indices snap back sharply, signal no slowdown
Indices at record levels, maintain 2011 IT spending growth at 6%
Conducted in mid-May, the latest Goldman Sachs IT spending survey regained its
footing after taking a pause in our April survey, with both the tech spending and capital
spending indices back to recent record levels.
Total IT spending index rebounds: to 72.5 from 68.0 (this includes salaries, services,
depreciation, occupancy, etc.) marking the second-highest index value since 2007 and
indicates that spending expectations remain strongly in expansion territory.
Tech Capital spending index rose: sharply to 72.5 in this survey, after notching down
to 66.0 in the April survey, which is the highest level since December 2006.
Maintain global IT spending forecast: Our global tech team maintains this at 6%,
mindful of some soft spots and lower Street expectations.
Pricing index notches down, but within historical values: After increasing for two
consecutive surveys, the pricing index notched down, but remains within its normal
historical range. Pricing remains one of the potential levers for Indian companies as
they look for ways to offset rising costs and wage inflation.
2H2011 looks strong: 2H2011 spending expectations reinforce strength of the indices
with a total of 28% of our panel expecting an acceleration from seasonal IT spending
for the second half of the year, which is twice the percentage of respondents who
expected an increase in 2H2010 versus 1H2010.
2011 expectations improved: In addition, IT spending expectations for 2011 improved
from the last survey with 40% of respondents (12 ppt higher than last survey)
expecting better IT spending growth in 2011 versus 2010.
Macro data disconnect: We note that most macro data points we assess have
notched down, including GDP revisions downwards. However, these are offset by
intact corporate profit growth, pricing, normal seasonal spending, and secular IT
spending drivers.
Retain 24% revenue growth for Indian IT svcs – 2H11 looks strong
The GS IT Spending survey provides a positive read across for the Indian IT companies.
There have been concerns recently on the sustenance of overall tech spending and a
consequent slowdown in revenue growth momentum for the Indian IT companies.
However, the IT spending survey allays a large part of the concerns, with 89% of the
respondents expecting 2H2011 IT spend to progress at the normal or a higher pace. What is
more noticeable is the response that 93% of the respondents expect their organization’s
2011 IT spending growth to be the same or higher than 2010.
IT services – Discretionary spending trending positively
The GS IT Spending survey showed that budgets for discretionary IT projects that require
services from systems integrators, application developers, or other IT consulting
companies, including Indian IT companies, remain strong with an upward bias. More than
80% of respondents expect IT services budgets to remain stable with about 35% expecting
them to trend upwards.
Among the various service areas of IT services, infrastructure spend grabs the highest
share with 65% of respondents expecting increased spending in infrastructure services
over the next six months. This augurs well for HCL Technologies wherein we expect
Remote Infrastructure Management services to be one of the key drivers of our 21%
revenue growth forecast over FY11-FY13E.
1Q revenue growth to set the FY12 base; tax, wages to mute EPS
Revenue growth in 1Q should remain strong and set the base for FY12
We expect sequential revenue growth of 4.5% in 1QFY12E for the large caps vs. 4.9% in
4QFY11. In our view, the June quarter will set the base for FY2012 revenue growth for the
sector. Unbilled revenues, a leading indicator of revenue growth, increased by 13.5%
qoq last quarter (+10% for only the 2
nd
time in the last three years) and point towards a
strong quarter. Infosys, with a 27% jump in 4Q ,appears best placed to surprise on the upside.
Taxes, wage hikes, visa costs to weigh upon earnings in 1Q
Companies announced wage hikes effective from this quarter (except HCL), which will
impact EBIT margins by 100-150 bp in this quarter, offset by fresher hiring and lower
utilization rates at 71% for the sector (vs. 75% in 2QFY11).
Further, incremental visa costs will also impact margins. However, companies have
slowed down visa applications due to the increase in costs and concerns over visa usage
which will spread the incremental costs evenly over the year. (Refer to our report dtd. May
30, 2011, “Assessing industry impact on the current debate over US visas”). As of May 24,
only 12,300 petitions have been made for H-1B visas out of the 65,000 quota. Also, with the
end of STPI tax deductions with effect from April 1, 2011, tax rates for the sector will rise
by 320 bp qoq (rising to 23.3% for large caps) with the exception of INFY (at 27%)
Large caps to outperform as growth and returns favor valuations
Our bias towards large-caps supported by ytd outperformance
Large cap Indian IT companies have outperformed the broader market ytd (4%
outperformance vs. BSE-30) as well as mid cap companies in the sector (mid caps down
28% ytd), inline with our view at the beginning of the year that large caps will outperform
on the back of better growth visibility and scale benefits to absorb headwinds. Refer
report dtd. Jan 12, 2011, “2011: Revenue momentum accelerates; bias towards large-caps”.
However, concerns over sustainability of growth and resultant valuations have cropped up
in the last few months. We believe, this should be taken as an opportunity to increase
exposure to the sector. Indian IT remains the sector second highest within our India
coverage in terms of CROCI generation (Exhibit 17). Despite trading at a 28% premium to
MSCI India, the sector is still trading at 18X on 1-yr fwd P/E, at the lower end of its 6-year
historical trading range of 17X-21X.
Our top picks in the sector are HCL Technologies and Infosys offering 29%/23% earnings
CAGR over FY11-FY13E and 22%/21% potential upside respectively
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