IT: Advantage largecaps

The revenue growth differential between largecap and midcap information technology companies is expected to persist.

In a market buffeted by regulatory seesaws and volatility of capital flows, the information technology (IT) sector is seen as a good defensive bet. However, this is restricted to largecaps, which have proved resilient in downturns. Additionally, robust growth prospects (over 20 per cent next year, FY12) over the high base of the current year (23-28 per cent estimated revenue growth in FY11) justify the premium valuations.

With banking and financial services (BFSI) segment promising the highest growth, Wipro, which has a relatively lower BFSI exposure, is expected to lag its peers Infosys and TCS in revenue growth in the near term till this demand normalises. The difference in valuations reflects this revenue lag.

However, concerns persist on the demand front and analysts indicate that with European recovery still uncertain, the deal pipeline is not ideal. Margins will also trend down due to dollar-rupee volatility and attrition, which may have stabilised but not fallen. On an average, earnings will fall two per cent for every one per cent rise of the rupee, say analysts.

IT midcaps take the brunt of the talent crunch, which limits their scalability and impacts margins (last quarter mid-cap Ebitda, or, earnings before interest tax, depreciation and amortisation, margins narrowed by 450 basis points year-on-year, while large caps’ margins expanded). Their average growth is expected around 15 per cent over the next year given that pricing is the main weapon in their arsenal.

January is a month when IT budgets are finalised in the US. This will determine the deal volume. As a full-scale global economic recovery remains questionable, this is significant for the industry. But analysts don’t expect many surprises and believe that largecaps still hold the advantage.