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| Dose of realism for IT stocks |
| Malini Bhupta / Mumbai Apr 19, 2011, 00:27 IST |
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 In the wake of soaring oil prices and sticky inflation, the markets were betting on the technology stocks as a defensive strategy. Heavy buying pushed prices of large-cap IT stocks to all-time highs, as investors bet on the US-recovery-led growth.
Then, Infosys happened. After the IT-major unveiled the shocking fourth quarter numbers, many questioned if the Indian IT story was running out of steam.
CLSA in its note, after Infy’s poor result, sets the record straight. After questioning the road ahead for the sector, the note goes on to explain: “First, it quietens things down somewhat. We have noticed an urge to not only invest in the top-tier stocks in the sector, but also go down the chain to mid-caps. A dose of realism comes handy here.”
| FOURTH QUARTER FORECAST |
| Company |
Revenue
forecast
($ mn) |
Growth
forecast
Q-o-Q (%) |
EBITDA
margin
chg (bps) |
PAT
growth
Q-o-Q (%) |
| TCS |
2,216 |
3.40 |
-81 |
-0.80 |
| Wipro (IT Services) |
1,389 |
3.30 |
23 |
4.40 |
| HCL Tech |
903 |
4.40 |
53 |
10.80 |
| Tech Mahindra |
274 |
2.00 |
57 |
-11.30 |
| Mahindra Satyam |
289 |
1.90 |
45 |
-34.20 |
Wipro PAT Estimates on Consolidated Financials
Source: Standard Chartered Research Estimates |
As reality dawned, most IT stocks came off their all-time highs and lost most of the gains, as the market started wondering if Infosys’ poor showing was a sign of things to come.
Analysts believe the heydays are over. In the long-run, valuations of top-tier IT firms will have a lower tone. They would perhaps be in line with their global counterparts such as Accenture. At present, the top IT players are valued 20-22 times, whereas the global players are in the range of 15-16 times. But, that is likely over a two-three year period.
Despite all the bad news, it’s not the time to write the obituary of the IT services industry. While analysts are selectively bullish on the sector and some frontline stocks, most believe it’s time for a reality check. The days of high margins (30+ per cent) are over as the industry has matured. This is evident even from Infy’s earnings guidance. While the company has guided for a revenue growth of 18-20 per cent in dollar terms, the earnings guidance of Rs 126-128 a share, indicates the company will find it very tough to translate its dollar revenues into rupee profits.
Hemang Jani, senior vice-president (retail business) at Sharekhan, said: “Given that valuations were on the higher side, disappointing numbers from Infosys pushed the prices down and the market has toned down its expectations. However, nothing has happened globally to trigger a re-rating. Investors will take a call on the sector after the other companies announce their results.”
Given that Infosys is the bellweather and its score card has affected sentiment, the company is facing unique issues. While it has been chasing margins and walking away from deals which don’t give 30 per cent plus margin, its rivals have been looking at deals in a holistic way. Analysts claim TCS and Cognizant don’t mind sacrificing margins in some projects if they can make up in other deals where they have the pricing power. “Companies will see margin erosion of 150-200 basis points year-on-year. The option that companies have is to either sacrifice margins or move up the value chain,” says an analyst with a domestic brokerage firm.
The other issue is strengthening verticals. Cognizant, for example, has a very strong healthcare vertical and TCS has strengthened presence in infrastructure management services, a growing market. Infosys lags TCS (IMS accounted for 10 per cent of revenues in the third quarter) in this sphere, say analysts.
TCS has become the best pick of the sector. According to Standard Chartered Equity’s report, it is expected to post 3.4 per cent quarter-on-quarter revenue growth and a margin erosion of 81 basis points. Wipro, on the other hand, is expected to post a 3.3 per cent sequential growth in revenues and 23 basis point growth in margins. HCL Tech is expected to post sequential sales growth of 4.4 per cent and a 10.8 per cent growth in post-tax profit. Kartik Mehta, AVP Research at Sushil Finance, said: “Margins are coming under pressure due to wage inflation, currency appreciation and higher marketing expenses.”
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