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India IT services
Life after US debt downgrade
Event
Déjà vu – is it 2008 playing all over again? Indian IT stocks succumbed to the
global financial markets’ turmoil last week. Macro developments have once
again raised concerns about the demand outlook for Indian vendors, and stocks
were hurt badly as parallels were drawn to GFC in late 2008. Economic
conditions remain fluid, and it’s difficult to have a firm opinion on FY13
estimates in the current situation. In this note, we present three scenarios that
we think have a high probability of playing out over the next 12 months.
Sharp correction, but no bottom yet. Our India strategist, Rakesh Arora,
believes that markets could see more pain before bottoming. If this turns out
to be true, we believe leading IT stocks can see another 10% dip.
Impact
Valuations already one std. dev. below historical mean. We are conscious
of the demand headwind for the sector, but would refrain from turning
hawkish. We have two reasons for retaining our positive view. First, in the
period following the GFC, both large and small IT vendors have proved
conclusively that the business model is robust and can withstand cyclical
pressure. Second, our scenario analysis and valuation study suggests that
risk-reward at this stage is in favour of Indian IT players.
Limping back to growth: Scenario 1. This scenario calls for average growth
in the high teens-to-low 20% area in FY12, and an uncertain macro implies
that FY13 could see high single-digit growth in the top line. We have
assumed that currency would be more benign at Rs44.50/US$ vs. our current
estimate of Rs43/US$. Our analysis assumes that companies would have
ample time to react to a sluggish outlook and to keep a tight lid on margindeterrent
factors like hiring, wage hikes and bench strength. We believe
current stock prices are discounting this view.
It’s business as usual: Scenario 2. With a change in investors’ risk
perception of equities, we see swift and attractive stock returns if companies
deliver on current consensus expectations. At present, sell side estimates are
factoring in 15-20% earnings growth for the leading vendors.
We all fell down: Scenario 3. Our worst case scenario is reminiscent of the
Lehman collapse and assumes that decision making comes to a complete halt.
Our calculation assumes 0% QoQ growth in 2H FY12 and flat revenues for
FY13. The two major deviations from the GFC era could be in FX movement
and billing rates. For our study, we have assumed that the rupee appreciates to
43, but we think pricing is unlikely to collapse in a way similar to 2008. If things
were to play out as outlined above, FY13 earnings could be cut by as much as
20%, and stocks could fall by another 10% from these levels.
Outlook
Stick with the leaders. In a difficult business environment, the sector leaders
should emerge stronger. We favour TCS and Infosys among the large-caps
and think HCLT remains the beta play in the sector. Among mid-caps, we
believe its attractive hedge position makes Hexaware stand out.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India IT services
Life after US debt downgrade
Event
Déjà vu – is it 2008 playing all over again? Indian IT stocks succumbed to the
global financial markets’ turmoil last week. Macro developments have once
again raised concerns about the demand outlook for Indian vendors, and stocks
were hurt badly as parallels were drawn to GFC in late 2008. Economic
conditions remain fluid, and it’s difficult to have a firm opinion on FY13
estimates in the current situation. In this note, we present three scenarios that
we think have a high probability of playing out over the next 12 months.
Sharp correction, but no bottom yet. Our India strategist, Rakesh Arora,
believes that markets could see more pain before bottoming. If this turns out
to be true, we believe leading IT stocks can see another 10% dip.
Impact
Valuations already one std. dev. below historical mean. We are conscious
of the demand headwind for the sector, but would refrain from turning
hawkish. We have two reasons for retaining our positive view. First, in the
period following the GFC, both large and small IT vendors have proved
conclusively that the business model is robust and can withstand cyclical
pressure. Second, our scenario analysis and valuation study suggests that
risk-reward at this stage is in favour of Indian IT players.
Limping back to growth: Scenario 1. This scenario calls for average growth
in the high teens-to-low 20% area in FY12, and an uncertain macro implies
that FY13 could see high single-digit growth in the top line. We have
assumed that currency would be more benign at Rs44.50/US$ vs. our current
estimate of Rs43/US$. Our analysis assumes that companies would have
ample time to react to a sluggish outlook and to keep a tight lid on margindeterrent
factors like hiring, wage hikes and bench strength. We believe
current stock prices are discounting this view.
It’s business as usual: Scenario 2. With a change in investors’ risk
perception of equities, we see swift and attractive stock returns if companies
deliver on current consensus expectations. At present, sell side estimates are
factoring in 15-20% earnings growth for the leading vendors.
We all fell down: Scenario 3. Our worst case scenario is reminiscent of the
Lehman collapse and assumes that decision making comes to a complete halt.
Our calculation assumes 0% QoQ growth in 2H FY12 and flat revenues for
FY13. The two major deviations from the GFC era could be in FX movement
and billing rates. For our study, we have assumed that the rupee appreciates to
43, but we think pricing is unlikely to collapse in a way similar to 2008. If things
were to play out as outlined above, FY13 earnings could be cut by as much as
20%, and stocks could fall by another 10% from these levels.
Outlook
Stick with the leaders. In a difficult business environment, the sector leaders
should emerge stronger. We favour TCS and Infosys among the large-caps
and think HCLT remains the beta play in the sector. Among mid-caps, we
believe its attractive hedge position makes Hexaware stand out.
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