IT Stocks - beneficiary of $ appreciation

Information technology (IT) stocks, which had underperformed the broader markets until mid-September, are now back in favour. Since 12 September, the CNX IT index of the National Stock Exchange has outperformed the benchmark Nifty by nearly 20%, more than making up for its underperformance earlier in the year.

Needless to say, this is because of the sharp depreciation of the rupee since August. It closed at 52.73 against the dollar on Tuesday, nearly 20% higher compared with levels of around 44 in early August.

According to an analyst with a foreign brokerage firm, every Rs. 1 increase in the rupee to dollar rate leads to an increase of around 3.5% in earnings for Infosys Ltd. The increase in earnings will be lower for firms such as Tata Consultancy Services Ltd, since they have hedged to a much higher extent. Even if one were to assume that the rupee to dollar rate in the medium term will average 50, this will lead to an over 20% increase in earnings estimates for Infosys compared with August.

Besides, the sharp rise in the rupee will provide a large margin buffer for IT companies, which will not only offset the pressure of wage inflation, but also companies’ leeway to spend more on sales and marketing to generate demand.

This is a welcome relief for companies in the sector as well as investors. In fact, a number of importer firms as well as companies with unhedged foreign currency borrowings are reeling under the pressure of a falling rupee. Given the widening trade deficit and the drop in portfolio and capital flows into the country, the fall in the rupee is expected to continue. In this backdrop, IT stocks may continue to outperform the broader markets.

Of course, the rise will be limited, given the weakening global macroeconomic situation. Infosys’ chief financial officer said on Monday that the company may miss the upper-end of its sales target for the December quarter and the fiscal year because of a deterioration in the global economic environment.

Even so, IT firms seem much better placed compared with firms catering to the domestic economy, which are grappling with high inflation, high interest rates as well as the impact of a declining rupee on their imports and borrowings.

Our Advise

Large Caps - Build your portfolio - hold long term

1. Infosys - Monthly High Rs.2875 and Low of Rs.2487 - Buy around 2500 on dips
2. HCL Tech - Monthly High Rs.380 and Low of Rs.450 - Buy around 400 on dips
3. Wipro - Monthly High Rs.387 and Low of Rs.327 - Buy around 350 on dips
4. TCS - Monthly High Rs.1040 and Low of Rs.1132 - Buy around 1060 on dips
5. Tech Mahindra - Monthly High Rs.640 and Low of Rs.543 - Buy around 550 on dips

Small Caps - Purely Trading bets - hold short term

1. Onmobile Monthly High Rs.640 and Low of Rs.543 - Buy around 550 on dips
2. Educomp Monthly High Rs.280 and Low of Rs.175 - Buy around 170 on dips
3. Mahindra Satyam Monthly High Rs.76 and Low of Rs.64 - Buy around 65 on dips
4. Mindtree Monthly High Rs.380 and Low of Rs.420 - Buy around 400 on dips
5. Patni Monthly High Rs.444 and Low of Rs.343 - Buy around 380 on dips

Source Livemint.com

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IT Sector - Outperform - Buy on dips

Mumbai: The September quarter results of India’s top four information technology (IT) outsourcing companies underscores the fact that demand for IT services is extremely strong. Cumulative revenues of Tata Consultancy Services Ltd (TCS), Infosys Technologies Ltd, Wipro Ltd’s IT services division and HCL Technologies Ltd rose by 10.3% quarter-on-quarter (q-o-q) to Rs. 25,688.6 crore.

But in the current demand environment, achieving high growth isn’t particularly difficult. It’s more important to assess how well India’s top IT firms have managed this growth spurt—in terms of employee resources and margins, and cash flow management.

Ahmed Raza Khan/Mint

Growth would have been higher at close to 12%, but for the relatively low growth reported by Wipro on Friday. Wipro’s volume growth was decent at 6.6% and compares reasonably well with Infosys’ 7.2% volume growth. But pricing was lower in constant currency terms and while its peers gained from the depreciation in the rupee last quarter, Wipro took a hit on account of its large forex hedge position. As a result, revenue grew by just 4.5% in rupee terms. For about a year-and-a-half now, Wipro’s revenue growth has been in the bottom end of the growth range of the top IT companies. It’s not surprising that Wipro’s shares have fallen by over 8% since the beginning of the current results season, much more than the 2.5% fall in the National Stock Exchange’s CNX IT index. While Wipro was at the bottom of the pile in terms of revenue growth, TCS led with an impressive 13% revenue growth. The firm’s volume growth of 11.2% was also the highest in the sector, and far higher than HCL Tech’s 7.9% volume growth and Infosys’ growth of 7.2%.

Also Read | Girish Paranjpe | Good quarter, but we could have done better

From an industry perspective, the important thing is that all top companies have grown volumes at a healthy rate. As one analyst from a foreign brokerage points out: “The nature of demand is extremely healthy, and growth isn’t merely being driven by pent up demand in the system. Clients are handing out work related to compliance, risk management, consolidation of ERP (enterprise resource planning) systems and supply chain integration.” Wipro, which is fairly accurate with its quarterly guidance estimates, has said that it expects revenue to grow by 3.5-5.5% in the December quarter. Assuming its peers are able to continue growing at a faster pace, industry growth is likely to be high even in Q3.

How well have India’s top firms managed this growth phase? While each of the top four firms have grown volumes at a decent pace, their ability to manage employee resources, margins and cash flows have differed substantially. Analysts at CLSA Asia-Pacific Markets point out in a note to clients, “Credit is due to TCS in manpower management, which has been the best in the industry. TCS has also faced industrywide headwinds of wage inflation. However, unlike Wipro, which cut manpower extremely aggressively in the slowdown, and Infosys, which reorganized its manpower through iRACE, TCS has been much more considerate to its employees. This is reflected in the much lower attrition, which has helped TCS service the demand upswing much better. This has also limited sub-contractor usage driving margin upsides.”

Attrition levels at Wipro and Infosys have been relatively high and the latter had to resort to high use of sub-contractors to meet the surge in demand last quarter. Besides, the latter has had to resort to out-of-turn promotions, while Wipro and HCL Tech have issued much higher number of options to employees below market price. The resultant increase in employee costs for these firms has impacted margins. As the chart shows, TCS and Infosys reported a strong growth in earnings before interest and tax, while earnings of Wipro and HCL Tech fell considerably. But note here that Infosys’ margins had fallen sharply in the June quarter and margins were expected to bounce back in the September quarter. Of the four firms, only TCS’ earnings have been meaningfully higher than Street expectations. TCS, however, benefitted from a one-off gain, thanks to which its rent costs fell by 46% q-o-q. But for this gain, margins would have been flat. Still, this doesn’t take away from the fact that the firm has managed its employee resources and margins relatively well.

Incidentally, TCS shares have risen by over 5% since the beginning of the results season last week, making it the only company among the top-tier firms to witness a rise in share price. Infosys and HCL Tech’s shares have fallen between 4% and 5%.

Despite the iRACE fiasco, Infosys’ performance on the margin front has been relatively good too. But Wipro and HCL have clearly disappointed as far as margins go, with the latter’s profit margins at their lowest levels in the last 12 years.

A similar difference is reflected in the cash flow generated by these firms. Here, Infosys leads the pack, with a free cash flow (FCF) of Rs.1,273 crore in the September quarter, which works out to an impressive 18% of its revenue. TCS isn’t far behind with an FCF/revenue ratio of around 15% last quarter. But Wipro’s FCF amounted to just 5.5% of revenue last quarter and HCL Tech reported a negative FCF. CLSA’s analysts note, “Such low margins and an inferior cash flow profile are a reflection of HCL’s strategy to trade growth for margins/earnings quality and recovering these will remain a challenge for HCL.”

In sum, growth in the current environment is almost a given for top IT firms. But not all Indian firms are managing this growth phase well.

mobis.p@livemint.com

Sridhar Chari in Bangalore and Surabhi Agarwal in New Delhi contributed to this story.

Source : Livemint.com

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IT shares slid on BSE / NSE on dashed budget hopes !

Shares of five information technology firms fell by 1.78% to 3.59% as some anticipated tax sops for the IT sector were not announced in the interim general budget.

External Affairs Minister Pranab Mukherjee, currently in charge of the finance ministry, presented the interim budget today, 16 February 2009.
At 14:04 IST, the BSE IT index was down 2.72% at 2,114.53. It, however, outperformed the Sensex, which was down 3.29% at 9,317.41.
TCS (down 1.78%), Infosys Technologies (down 2.69%), Wipro (down 2.88%), HCL Technologies (down 3.68%), and Hexaware Technologies (down 3.59%), slipped.
The information technology (IT) and information technology enabled services (ITeS) industry had anticipated the interim budget will extend the Software Technology Park of India (STPI) scheme beyond 2010. But there was no such announcement
Units situated in software technology parks falling under the scheme's umbrella are eligible for a 10-year income tax holiday, in addition to other benefits.
India's largely export-oriented software sector's fast pace of growth has been crimped by the economic slowdown in the US, which accounts for more than half of the sector's export revenues.
Earlier this month, the National Association of Software and Services Companies (Nasscom) slashed its software and services export target for the year ending March 2009 to about $47 billion, a growth of 16-17% and slower from an earlier target of 21-24%.