Indian IT Services -- Cash collection getting compromised? 􀀗HSBC Research,

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Indian IT Services
Cash collection getting compromised?
􀀗 Unbilled revenues and receivables are going up for the Indian
companies in the past few quarters impacting cash flows
􀀗 1Q FY12 sees no exception and the trend continues
􀀗 HCLT results on 27 July is the next trigger for the sector


1Q earnings season is broadly through this week (HCL reporting on 27 July). Broadly, most of the
global technology results (except for a few European software companies) have reported robust
growth, particularly reinforcing strong corporate spending and bias for growth and discretionary
projects. Indian IT companies have also maintained the trend seen in the past few quarters. TCS has
reported strong volume growth of near 7% sequentially, followed by Infosys of around 4% and then
with Wipro still involved in its internal restructuring. While volume growth has been the focus of
the quarter, we see increasing weakness in the cash collection (across all the companies) as trade
receivables and unbilled revenues have consistently gone up in the past few quarters.
Unbilled revenues for the top-3 companies have increased by 12-21% q-o-q this quarter,
compared to revenue growth of 0-7%. We have seen a similar trend in the past many quarters as
unbilled revenues have gone up consistently as % of total sales. Similar trends are observed when
we look at revenue receivables as well (refer fig 1). We believe this could be explained through the
following reasons: a) companies are reducing the focus on T&M and engaging with the clients by
taking higher risk through fixed-price contracts. Reported statistics however do not suggest that as
the proportion of fixed price contracts has not changed much in the past few quarters (fig 3); b)
Indian companies are doing higher proportion of long-term transformational deals where the initial
transition period is billed over the duration of the project and therefore sits on the BS as unbilledrevenues;
and c) from our discussion with the companies, in a high growth environment, usually
client-facing teams are more engaged in winning and delivering business than cash collection and it
is therefore a temporary phenomenon. While we don't fully negate this rationale, we believe the
continuation of these trends in the coming quarters would warrant higher attention.


Infosys
The stock is now trading at 20x FY12e EPS and 17x on FY13e EPS. We continue to value Infosys at 20x
FY13e EPS (in line with the historical average valuation) and therefore value Infosys at INR3,300.
Under our research model, for stocks without a volatility indicator, the Neutral band is five percentage
points above and below the hurdle rate for India stocks of 11%. This translates into a Neutral band of 6%
to 16% around the current share price. Our target price of INR3,300 suggests a potential return (including
a dividend yield) of near 20%, which is above the Neutral band; therefore, we maintain our Overweight
rating.
TCS
The stock is currently trading at 22x and 18x on our FY12/13e EPS. We maintain our estimates and
continue to value the stock at 22x FY13e EPS (10% premium to Infosys) at INR1,360.
Under our research model, for stocks without a volatility indicator, the Neutral band is five percentage
points above and below the hurdle rate for India stocks of 11%. This translates into a Neutral band of 6%
to 16% around the current share price. Our target price of INR1,360 suggests a potential return (including
a dividend yield) of near 20%, which is above the Neutral band; therefore, we maintain our Overweight
rating.
Risks
1. INR appreciation vs. USD (every 1% appreciation affects margins by 30-40bp) remains a concern
with foreign inflows into India increasing steadily;
2. Deterioration in macroeconomic conditions.