Are record high MF investments in IT companies a cause for worry?

Besides lacklustre numbers recently, Indian IT firms also lag in digital and consulting businesses, which are both growth areas;

While the rupee was losing its value on fears of money leaving the country in case of an interest rate hike in the US, Indian mutual funds were trying to play the scenario by stacking up on IT sector stocks. A depreciating currency would benefit all exporting companies, including the software sector.

Credit Suisse pointed out that recent currency moves are positive for the software sector. In August 2015, strength in the Euro and Japanese Yen, along with depreciation in the rupee, has more than offset the dollar appreciation against relatively less material currencies such as the Australian Dollar and Canadian Dollar. Rupee depreciation is EPS-accretive in in the second quarter as cross-currency headwind is only minor.

Assuming current exchange rates, there should be a net positive impact of 230 basis points in revenues in rupee terms and around 70-90 bps in margins. Credit Suisse says that the weak rupee will lend support to FY16 revenues. Rupee will result in a 290 basis point positive impact on revenues in FY16 for the larger firms in the sector. Over 6% rupee depreciation should offset cross-currency headwinds of over 300 basis points and result in an 80-100 bps benefits on the margins. The numbers are made on the assumption that global factors will not impact demand.

But is this a good enough reason to hold record level of stocks in software sector?

In its recently declared results, software consulting company Accenture posted strong numbers for the quarter ended August. However, the company has given a softer outlook for the future. Nomura, in its research report, has pointed out that better growth at Accenture in an environment where demand is not exuberant does not necessarily mean similar positivity for Indian IT companies. Accenture is the strongest player in digital space, it competes aggressively in outsourcing with more offshore (global delivery network) headcount than all tier-1 IT companies (excluding TCS), and is the strongest player in consulting (where Indian IT has a limited presence).

Nomura cautions that Accenture’s results might not see any worsening of demand in the near quarters but the outlook could see tempering as macro indicators on demand have worsened. Deceleration in growth has been seen at Accenture in outsourcing, wherein growth has come down from 14% YoY in constant currency terms to 9% over the past 3 quarters. Outsourcing is the more relevant segment from an Indian IT perspective.

Further, Accenture has hinted that growth will soften next year on account of scale and the fact that macro has worsened over the last 90 days. June quarter numbers of the top IT players was nothing much to write about. The top five companies posted an revenue growth of 5.9%, which included currency benefits.

Indian companies have only a tentative toehold in the digital space, which is one of the fastest growing segments. The difference the segment made on Indian company results can be seen from a 15.6% growth posted by Cognizant as compared to a 6.5% by TCS, mainly due to robust growth in digital space for the former.

JP Morgan Research in a recent note had pointed out that Cognizant and Accenture have shown much more urgency in building digital capabilities which has resulted in better growth compared with companies in Indian listed space. The report points out that Indian company’s success in digital space entail a refined degree of skill in these areas. This means specialised boutique shops. Both Accenture and Cognizant have acquired a number of companies in the digital space to grab the opportunity. Indian companies are trying to reinvent the wheel. It’s still early days in the digital space and one hopes to see acquisitions from Indian companies in this space to catch up on growth.

Though Indian mutual funds have stacked up hoping on a depreciating currency, the ground realities of a business growth does not show any improvement. In fact HCL Tech has issued a profit warning for the quarter, saying that growth will be tepid. Will this now result in a rush to the exit door?While the rupee was losing its value on fears of money leaving the country in case of an interest rate hike in the US, Indian mutual funds were trying to play the scenario by stacking up on IT sector stocks. A depreciating currency would benefit all exporting companies, including the software sector.

Credit Suisse pointed out that recent currency moves are positive for the software sector. In August 2015, strength in the Euro and Japanese Yen, along with depreciation in the rupee, has more than offset the dollar appreciation against relatively less material currencies such as the Australian Dollar and Canadian Dollar. Rupee depreciation is EPS-accretive in in the second quarter as cross-currency headwind is only minor.

Assuming current exchange rates, there should be a net positive impact of 230 basis points in revenues in rupee terms and around 70-90 bps in margins. Credit Suisse says that the weak rupee will lend support to FY16 revenues. Rupee will result in a 290 basis point positive impact on revenues in FY16 for the larger firms in the sector. Over 6% rupee depreciation should offset cross-currency headwinds of over 300 basis points and result in an 80-100 bps benefits on the margins. The numbers are made on the assumption that global factors will not impact demand.

But is this a good enough reason to hold record level of stocks in software sector?

In its recently declared results, software consulting company Accenture posted strong numbers for the quarter ended August. However, the company has given a softer outlook for the future. Nomura, in its research report, has pointed out that better growth at Accenture in an environment where demand is not exuberant does not necessarily mean similar positivity for Indian IT companies. Accenture is the strongest player in digital space, it competes aggressively in outsourcing with more offshore (global delivery network) headcount than all tier-1 IT companies (excluding TCS), and is the strongest player in consulting (where Indian IT has a limited presence).

Nomura cautions that Accenture’s results might not see any worsening of demand in the near quarters but the outlook could see tempering as macro indicators on demand have worsened. Deceleration in growth has been seen at Accenture in outsourcing, wherein growth has come down from 14% YoY in constant currency terms to 9% over the past 3 quarters. Outsourcing is the more relevant segment from an Indian IT perspective.

Further, Accenture has hinted that growth will soften next year on account of scale and the fact that macro has worsened over the last 90 days. June quarter numbers of the top IT players was nothing much to write about. The top five companies posted an revenue growth of 5.9%, which included currency benefits.

Indian companies have only a tentative toehold in the digital space, which is one of the fastest growing segments. The difference the segment made on Indian company results can be seen from a 15.6% growth posted by Cognizant as compared to a 6.5% by TCS, mainly due to robust growth in digital space for the former.

JP Morgan Research in a recent note had pointed out that Cognizant and Accenture have shown much more urgency in building digital capabilities which has resulted in better growth compared with companies in Indian listed space. The report points out that Indian company’s success in digital space entail a refined degree of skill in these areas. This means specialised boutique shops. Both Accenture and Cognizant have acquired a number of companies in the digital space to grab the opportunity. Indian companies are trying to reinvent the wheel. It’s still early days in the digital space and one hopes to see acquisitions from Indian companies in this space to catch up on growth.

Though Indian mutual funds have stacked up hoping on a depreciating currency, the ground realities of a business growth does not show any improvement. In fact HCL Tech has issued a profit warning for the quarter, saying that growth will be tepid. Will this now result in a rush to the exit door?