Sustainable recovery

The superlative December quarter results from the Big Three IT companies renewed hopes that the worst is over for the IT sector. Higher volumes helped the tech majors to deliver the goods in a traditionally weak quarter. While the improvement in the global economic situation is a positive, the lack of pricing improvement suggests that clients of Indian tech majors are still not out of the woods. Many had expected the top domestic IT companies to report flattish revenue growth for the quarter. However, better volumes ensured that revenues of the top three companies, which account for over 85 per cent of the weight in the BSE IT index, grew at an average of around 2 per cent in rupee terms and 6 per cent in dollar terms, on a sequential basis. The North American market and banking and financial services and insurance (BFSI) space which stabilised in June 2009 quarter, saw improvement in September quarter which strengthened in December quarter on the back of higher volumes. On top of it, better than expected margins indicate that the companies were able to rein in costs without hampering growth. However, despite good results, IT stocks were not exactly chart toppers on the indices. The reasons? Negative sentiments surrounding the proposed restriction on US banks and IT stocks that were major outperformers in the last three months are cooling off; the Big Three delivered an average return of 23-25 per cent compared to flat Sensex returns. A strengthening rupee could be a medium-term dampener.

Outlook improves
IT global spending is estimated to have declined 5-6 per cent last year which saw IT majors report an average negative 1-3 per cent sequential decline during the first half of CY2009. However, key indicators of economic recovery such as stability in US home sales and good earnings numbers boosted sentiment. Both, IBM and Intel have reported a good performance recently. The recovery is not limited to the US. Gartner expects the global growth to return with IT spends expected to increase 4.6 per cent to $3.4 trillion in CY2010. “The technology downturn of CY2008 and CY2009 is unofficially over,” said Andrew Bartels, vice president and principal analyst, Forrester Research. He adds, “All the pieces are in place for a CY2010 tech spending rebound. In the US, the tech recovery will be much stronger than the overall economic recovery, with technology spending growing at more than twice the rate of gross domestic product (GDP) this year.” Western and Central Europe are estimated to outperform with tech purchases rising by 11.2 percent, boosted by the dollar’s decline against the euro.

Deal flow rising?
While business confidence is getting restored, earlier investments on the sales and marketing front (strengthening client partnerships) are also paying dividends for IT companies. However, most top IT vendors sound cautiously optimistic regarding growth prospects. Kris Gopalakrishnan, CEO & MD, Infosys Technologies, “Indications are that the budgets are going to be flat but offshore-outsourcing would go up. About 60 per cent of the clients are yet to finalise. The allocations have to be made. It is also possible that because the budgets are not closed there may be delays.”

Notably, the recent quarter saw a visible improvement in new client additions by the IT companies with the signing of deals in the $100-200 million range. N Chandrasekharan, CEO and MD of Tata Consultancy Services (TCS), further adds, “We are pursuing 20 large deals and the pipeline looks healthy, however, it will take at least a few more quarters for pricing power to return.”

Broader recovery
Among key verticals, the BFSI space which accounts for more than a third of revenues of top IT companies, helped deliver a robust quarter. Infosys’ BFSI revenues grew by 6 per cent sequentially (it added 14 BFSI clients during the December quarter), while the same for TCS and Wipro was 3 per cent and 1.6 per cent, respectively. Positively, the companies also indicated that demand from customers from other segments such as retail, energy, utilities and pharmaceuticals is also improving. Nevertheless, the companies are still cautious about the recovery in the manufacturing and telecom segments. Should there be a pick-up in these segments, expect growth rates to be better than the 2010 forecast.

Within geographies, the US which accounts for nearly three-fifths of the total IT revenues held up well. However, contributions from other geographies like India and rest of the world, which though contribute between 12-16 per cent to total revenues of the top companies, did better with revenues growing between 9-20 per cent sequentially. Nevertheless, a recovery in Europe, which is expected to lag the US recovery by 1-2 quarters, would be crucial for the momentum to sustain.

Margin trend
Operating profit margins (OPM) in the third quarter improved. While Wipro’s OPM improved by 40 basis points, the other two majors saw margins improve by 90 to 120 basis points. Lower administration and selling expenses helped to some extent. The higher employee utilisation of around 80 per cent was the larger contributor to margin improvement. With business prospects expected to improve, IT companies have gone into the hiring mode again. The Big Three added a net of around 17,000 employees during the quarter, besides scaling up yearly hiring targets and bench strength to meet the higher forecasted demand. The gross hiring for IT majors is estimated to be 20,000-22,000 for the fourth quarter as against about 24,000 in the December 2009 quarter.
 

MID-CAPS: SHOWING SIGNS OF RECOVERY
in Rs crore	Sales growth (%)		OPM (%)		Net profit growth (%)		Dec ‘09 quarter		Price  (Rs)	PE (x)
	Dec ‘09	Sep’09	Dec ’09	Sep ‘09	Dec ‘09	Sep ‘09	Net Sales	Net Profit
Rolta India	7.2	5.3	37.9	35.8	11.9	-26.4	375.6	62.8	188.0	48.1
Mindtree	5.4	3.4	19.8	20.9	7.8	-12.1	331.9	53.8	639.0	47.0
CMC	-3.5	4.0	20.8	18.0	4.6	23.7	211.2	36.3	1224.0	51.2
Infotech Enterp.	0.7	2.1	21.7	21.7	7.3	-23.6	239.1	37.9	325.0	47.5
Polaris Soft.	0.2	3.9	14.9	13.3	13.8	10.6	338.9	40.1	175.0	43.1
Glodyne Techno.	9.1	11.6	23.5	23.0	13.9	10.0	187.8	28.5	528.0	41.5
NIIT Tech.	1.7	3.7	22.0	20.3	10.0	82.4	230.1	35.3	186.0	31.0
Mastek	0.8	-6.5	12.2	15.5	-10.9	-25.1	190.9