IT Services: A quiet quarter

With the environment still challenging, IT firms are likely to turn in a muted set of results for the June 2009 quarter; volumes are expected to come down sequentially with no uptick in pricing. The accompanying commentary will almost certainly be cautious given that the order pipeline is more or less flat, customers are taking their time to close deals and also because clients continue to expect further cuts in pricing.

However, the market is in a better situation than six months back with projects being renewed. The TCS management is believed to have indicated, a couple of weeks back, that dollar revenues could start picking up and show a sequential growth as early as in the second half of the year. That’s encouraging because TCS has posted dollar revenue declines in three of the last four quarters despite adding clients mainly due to pricing pressures and key Wall Street clients ramping down business.

However, as of now, the rupee has appreciated during the quarter though the June quarter numbers may not reflect the entire damage thanks to cross-currency movements (the dollar has depreciated against the euro and the pound). On the whole, therefore, revenues for the top-tier players shouldn’t come off by more than 2 per cent sequentially. Infosys’ operating margins, which were a strong 33.6 per cent in the March quarter, may slide somewhat.

Expectations of a turnaround in the marketplace in the next few months seem misplaced —it's unlikely any company will alter its guidance meaningfully. Since the June quarter will see weak revenues, vendors will need to grow revenues by 2-5 per cent in the next three quarters to maintain last year's numbers.

Given this, IT stocks are unlikely to trade at higher valuations in the near term. At Rs 1,706, Infosys trades at 17.4 times its estimated 2009-10 earnings, while at Rs 380, TCS trades at 14 times. The abolition of the fringe benefit tax will help IT companies’ earnings in the current year, but not too significantly.