IT firms: Rebooting on recovery

Strong second-quarter results may provide the much-needed trigger to frontline IT stocks.

Predicting the performance of information technology (IT) stocks has become a difficult task for investors, given that these companies derive most of their revenues from the US and Europe, where the economic situation has been uncertain. While some analysts believe software services will struggle beyond FY11, others think the future is bright. As the US economy recovered in 2009, the BSE IT index outperformed the Sensex by a huge 45 percentage points in FY10. But over the past six months, tech stocks have been dragging, given concerns over rising costs and high valuations.

While sector analysts’ FY11 earnings estimates are optimistic, investors are worried that the global downturn may be prolonged and the protectionist rhetoric emerging in the US and Europe could be detrimental to business. Expectations of a stronger rupee are an added, although marginal, worry.

However, some analysts refute this view and say the sector has more horse power than visible. With most of the negatives on the margins front over, strong earnings growth kicker due in the September quarter results (seasonally strongest quarter) could propel earnings upgrades. With Infosys and TCS done with salary hikes and hiring in the past two quarters, analysts expect margin expansion to be boosted by higher volumes.

On the demand front, brokerage firm CLSA sees an increase in discretionary spending due to strong Oracle licence sales. Also, the global corporate sector is cash-rich now, which was not the case in 2008-09. New demand is expected from regulatory requirements in the financial sector, healthcare and also in areas like cloud computing.

The big three – TCS, Infosys and Wipro – are expected to clock five-six per cent growth in dollar terms in the current quarter and follow it up with about 20 per cent y-o-y growth in FY12. The rupee has depreciated about two per cent sequentially during the September quarter, which will boost earnings. But, analysts expect the rupee to appreciate in the second half of FY11, which may put some pressure on IT firms later this year.