Sunday, October 9, 2011

Indian IT Sector to post muted growth

Nomura Financial Advisory and Securities has assigned `Buy` and `Neutral` rating on the following 5 IT stocks. The rationale for the rating is as follows:

HCL Technologies - Buy
CMP: Rs 409
Target Price: Rs 530
Upside 29.5%

Revenue growth of 5.4%, margin decline of 140 bps in 1QFY12 expected:

We expect HCL Tech to deliver US dollar revenue growth of 5.4% q-q in 1Q FY12F along with a 140bp decline in EBITDA margin from wage hikes and fresher recruitment, cushioned by rupee depreciation. Management commentary on the deal pipeline and win-rates will be keenly watched.

Top pick in IT for highest absolute return potential:

HCL Tech`s market share gain focus and lower margin expectations should aid in competing better in a growth slowdown scenario, in our view. We derive comfort from revenue surety on strong deal wins/pipeline exhibited by: 1) USD 2.7 billion worth of TCV signed in BFSI/manufacturing in FY11; 2) about USD 2 billion worth of deals in BFSI in the pipeline; and 3) anticipated strong deal decision making in the December 2011 quarter with a record-high pipeline. Valuations seem to be building in a worst-case scenario of severe pricing cuts, which we believe is unlikely. In our view, its valuations and best-in-class earnings growth provide comfort for implied upside of 30% from current levels. HCL Tech remains our top pick in IT.

Catalyst: Decision making on deals in line with expectations in the December 2011 quarter and an absence of pricing cuts.

Reiterate `Buy` and target price of Rs 530 based on 15x FY13F:

We expect a USD revenue CAGR of 19% and EPS CAGR of 24% over FY11-13F. Our estimates are marginally revised upwards for rupee depreciation. We retain our target price of Rs 530, based on 15x FY13F earnings.

Infosys - Buy
CMP: Rs 2,533
Target Price: Rs 2,900
Upside 15%

Possible negative reaction to guidance cut; accumulate on declines:

We expect 2QFY12 results to be in line with guidance on USD revenues (4.9% q-q), to surprise positively on EBITDA margins (est +110 bps q-q) and come in ahead of guidance on EPS (est Rs 35.7 vs guidance of INR 30.2) driven by rupee depreciation. We see disappointments on a cut in FY12F revenue guidance, which we think is highly probable given: 1) project delays/deferrals and discretionary spending curtailments; and 2) adverse cross-currency movements. Infosys has significant operational scope to tide over demand moderation and we find comfort in valuations which are already factoring in a possibility of guidance downgrade and growth moderation to the low-teen levels in FY13F. Reiterate `Buy`.

Expect FY12F revenue guidance cut and EPS guidance raise:

We expect a cut in USD revenue growth guidance from 18-20% to 16-18% on: 1) growth moderation; and 2) cross-currency impacts. We think EPS guidance is likely to be raised to around Rs 135 from Rs 128-130 earlier on: 1) rupee depreciation; and 2) cost curtailments in a growth moderation environment. Expect 3QFY12F revenue growth to be guided at 3-4% q-q.

Catalyst: Keeping revenue growth guidance unchanged would be a positive trigger.

Raise target price to Rs 2,900, reiterate `Buy`:

We raise our target price to Rs 2,900 (vs Rs 2,800 earlier) based on 18x FY13F earnings on a marginal improvement in earnings on rupee depreciation. Maintain `Buy` on better operational scope and comfort on valuations.

Patni Computer Systems - Neutral
CMP: Rs 289
Target Price: Rs 300
Upside 3.8%

 Weak revenue outlook in the price; upgrade to `Neutral`:

Patni has corrected by 39% (vs 19% correction for the Nifty) YTD and is now trading at 10x FY12F EPS. Post this correction, we see limited downside given: 1) likely sequential margin and EPS improvement for the next few quarters primarily on the back of G&A savings; 2) a cash balance of Rs 130 a share (45% of market cap); and 3) Igate`s expressed preference for a delisting, which could result in shares being acquired at a premium to current prices. Upgrade Patni to Neutral.

Not a `Buy` yet, as revenue and governance concerns remain:

Patni`s revenue growth will be sluggish, in our view, (we model 6.6% CAGR over FY10-12F) as margin improvement seems to be the primary focus of management. Also, we still have concerns on allocation of costs and revenues to Patni under a common Igate-Patni front-end.

Catalyst: Change in delisting plans, improvement in revenue growth

An Igate decision to cut its stake instead of delisting could lead to valuation multiple de-rating. Any sign of Patni breaking out from the sub-4% sequential revenue growth pattern could lead to a re-rating in the stock.

Raise target price to Rs 300 based on 10x 1-yr forward earnings:

Our diluted EPS estimates are higher by 6%/3% to Rs 25.4/28.3 in FY11/12F on 1) rupee depreciation; and 2) higher G&A savings, despite cut in FY13F revenue estimates.

Tata Consultancy Services - Neutral
CMP: Rs 1,037
Target Price: Rs 1,070
Upside 3.18%

2QFY12F - 5%+ revenue growth; forex losses to weigh on earnings:

We expect TCS to report USD revenue growth of 5.4% q-q in 2Q FY12F. EBTIDA margins are likely to improve by 80bps q-q on better rupee realisation and SG&A leverage. Forex losses could depress the positive impact of rupee depreciation on earnings. Management commentary on demand and pipeline will be key things to watch for, as we sense some moderation in management optimism over the past few quarters.

High BFSI/Europe exposure a risk; remain `Neutral`:

We see the key risk at TCS being its high banking, financial services and insurance (BFSI) and Europe exposure. These were the first segments to be hit in the previous downturn, and we expect a repeat of the same scenario. Valuations still appear to build in higher-than-peer-group optimism on future growth given strong management commentary and superior results of late, which could be at risk in a growth moderation scenario. We maintain our Neutral rating, despite continuation of growth momentum in the near term. Amongst Tier-1 stocks, we prefer Infosys and HCL Tech.

Catalysts: Economic uncertainty shifting to individual clients and management commentary turning less upbeat on demand.

Raising target price to Rs 1,070; remain `Neutral`:

We have raised our EPS estimates marginally on rupee depreciation. This leads to our TP being raised to Rs 1,070 (from Rs 1,050), based on 18x FY13F earnings. We remain cautious on TCS on its high BFSI/Europe and client concentration, coupled with lesser comfort on valuations.

Wipro - Neutral
CMP: Rs 341
Target Price: Rs 340
Downside 0.3%

2QFY12 - 3% revenue growth, 200 bp margin decline expected:

We expect Wipro`s IT Services business to post USD revenue growth of 3.4% q-q (1.3% organic growth), which would be near the higher end of its guidance (2-4%). EBIT margins in IT services are likely to dip by 200 bps q-q on the partial impact of wage hikes and the SAIC acquisition. We think there could be disappointment if Wipro guides for less than 3% q-q growth in 3Q.

Downturn a setback to revival efforts; maintain `Neutral`:

We believe the economic uncertainty and impending growth moderation have come at the wrong time for Wipro, which is trying to restructure and close the growth gap with its peers. We see economic uncertainty setting back Wipro`s revival efforts, adding to the high risks to growth in FY13F on account of: 1) weak near-term deal flow; and 2) slow decision-making reducing the possibility of a near-term revival. Wipro remains our least preferred tier-1 Indian IT stock, as we believe it has the slowest earnings and revenue growth outlook among peers and lacks immediate triggers.

Catalysts: Continued underperformance on growth and pricing cuts.

Raise TP to Rs 340 based on 14x FY13F EPS:

We expect Wipro to deliver a CAGR of 11% in revenue growth and 6% in EPS over FY11-13F. The 14x multiple is a 20% discount to our target multiple for Infosys and TCS, justified given the lag in revenue revival and below par earnings growth.
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