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Sector View - Information Technology

Monday 24 September 2012

By Dipen Shah, Kotak Securities

The stocks of IT companies have recovered and performed well over the past few weeks, after Infosys rocked the sector once again in July. Infosys has desisted from giving quarterly guidance for the first time in several years. We take stock of the results and the outlook for the sector. The results and the outlook given by companies were a mixed bag.

Results
As far as 1QFY13 results of large-cap companies are concerned, Infosys and Wipro continued to post lower-than-expected numbers, whereas TCS and HCLT continued to meet expectations. Cognizant has also met its quarterly guidance and has maintained its full-year guidance. While the economic slowdown has impacted overall growth rates, the difference in performance of different companies is likely due to company-specific issues like:

Varying exposure to impacted verticals like BFS, Telecom, etc.
Exposure to troubled clients, especially in BFS, utilities, Telecom, etc.
Issues like management re-structuring, corporate strategy, etc.

One notable feature of the results is the reduction in average realisations for most large companies. While companies have attributed a large part of this to mix change and one-off re-negotiations, it will be a closely-watched matrix in 2Q.

Performance of mid-cap companies was relatively better with volume growth matching expectations and pricing pressure being relatively lower. Mid-tier companies have performed relatively better likely because of their size and their level of engagement with clients. A changing pattern of spending by clients is also possibly helping them.

The size and level of engagements of mid-tier companies with their clients is relatively smaller. To that extent, there is potential for the client to increase the work with the vendor as compared to some of the large companies, where few clients have probably reached saturation levels. The pattern of spending is also changing with clients breaking down large deals into smaller ones (they do not want to commit large spends in these uncertain times). With the deal sizes getting smaller, mid-tier companies are invited to bid and they are successful in a few of these. They are able to provide better top-management attention.

A few companies like TCS, HCL Tech, Geometric, KPIT, Zensar have given a positive outlook. We tried to analyse this divergence.

We understand that, apart from client exposures, focus on verticals which are less stressed, has also given more confidence to these companies. TCS and HCLT have indicated that, verticals like Auto, Hitech and Manufacturing, apart from Insurance, are seeing stable decision making cycles and also spends. KPIT and Geometric have sizeable exposure to these verticals and hence, their commentary has been more positive as compared to other mid-caps. If this trend continues, they may report relatively better growth rates for the fiscal. NIIT Tech has high exposure to Insurance and should have done well. But, scale downs in BFS segment impacted overall growth.

Our Take

We understand that, the velocity of decision making by a majority of clients has remained the same as earlier (it has not deteriorated, either). The impact has been more the discretionary projects, which can be postponed easily by companies. We also have seen reduction in average realisation for several companies and we need to watch out for the same.

Stocks have done well over the past few weeks, after falling on Infosys results. TCS and HCLT have restored some confidence within the sector. Also, the dismissal of the harassment case against Infosys in US boosted sentiments. Further, expectations of liquidity easing in developed markets have supported stocks, we believe.

The recent liquidity push by the ECB and Fed will likely support the developed economies though, these are still far away from being cured. The improved sentiment might result in faster decision making by client companies, improving the demand scenario for Indian IT companies.

With the recent upmove in prices, the valuations have also moved up to near fair levels based on FY13 estimates. While we expect a better demand scenario for companies in the next few quarters, a measured approach towards the sector is called for.

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