Brokerages positive on IT first quarter performance on good demand, broad-based user spending  

July 6, 2011

Cross-currency movements also favour higher dollar revenues, but increased manpower costs could result in a decline in margins

Moneylife Digital Team

The information technology (IT) sector should put in a positive performance in the June quarter, as the demand landscape remains unscathed and user spending continues to be broad-based, says Angel Research. Besides, cross-currency movements favour growth in US dollar revenues and a surge in overall revenues. However, there could be a possible decline in margins on account of increased manpower costs, as well as an overall slip in earnings of the order of 7% to 9% for the market leaders or even higher for smaller companies.

The demand environment for most Tier-I IT companies is marked by positive client budgets across industries, with the exception of telecom, a higher component of offshore assignments for clients, an ability to satisfy surging demand with upbeat gross hiring guidance for 2011-12. (Infosys and Tata Consultancy Services say they are adding 45,000 and 60,000 employees respectively.)

In spite of the favourable environment, there is a cause for concern in the looming macro economic scenario that may see a delay in client projects. The pent-up budget flush is not happening as planned, because clients are turning marginally cautious about the economic recovery. However, there are no indications of any budget cuts from clients yet and IT companies continue to see robust demand for discretionary services going ahead.

Recently, Gartner Information Technology Research revised its growth on IT spending for 2011-12 from 5.6% year-on-year to 7.1% y-o-y.

As per NASSCOM's strategic review in February 2011, worldwide IT spend is expected to grow by about 4% in 2011-12. As for industry-wise trends, the BFSI (banking, financial services and insurance) segment that contributes about 45-50% to exports, will continue to lead in terms of volume due to persistent work related to regulatory compliance, data analytics, operational efficiency and risk and fraud prevention issues.

Sharekhan also has a positive demand outlook for the IT sector over the next 12 months. It says that despite the macro-economic headwinds, mainly the slow recovery of the US economy and the European debt crisis, the demand environment remains strong, with higher client spends towards regulatory changes, higher globalisation and newer technologies like cloud and analytics.

One example is Oracle, which has reported strong new licence sales (up 19.2% y-o-y to $3.74 billion) that would have a multiplier effect on the market for Oracle-based assignments.

However, negative news flows and disappointment over quarterly performance would impact stock performances. Sharekhan expects Infosys to have a negative q-o-q growth of 4.1% in net profit (Rs1,743 crore) in the June 2011 quarter. It also expects Tata Consultancy Services to announce negative q-o-q growth of 5.9% in net profit (Rs2,260 crore).

Motilal Oswal Securities (MOSL) believes the demand in the IT sector is fundamentally intact from the near-term perspective, and it has revised its estimates only marginally. Increased rhetoric around visa issues and the macro slowdown in the US are negative factors affecting market sentiment.

Visa issues have not impacted operations of most Indian IT companies in any material way, as increased scrutiny is an ongoing feature of the US visa process. Deal pipelines in terms of volume and size remain strong and demand is getting broad-based, as lagging verticals like manufacturing show improvement. Infosys registered a net profit of Rs6,800 crore in 2010-11, while TCS recorded a net profit of Rs8,700 crore.

Macquarie Research believes that revenue growth in 2011-12 could trigger margin expansion from the 2010-11 level. These companies have faced wage inflation and rupee appreciation last year, and with robust demand they should be able to reverse the profitability trend seen last year.

But IDFC Securities sees divergent trends among the top four companies. TCS could achieve the highest q-o-q US dollars revenue growth of 6%, while HCL Tech could grow at 5%, Infosys at 4% and Wipro 2%. The revenue growth is to be largely volume driven with some pricing improvement.

On the contrary, q-o-q margins are to decline largely on the back of wage hikes and visa costs. The decline in margins for the market leaders includes Infosys 270 basis points, TCS 210 basis points, and Wipro 40 basis points. The exception is HCL Tech, which will achieve 70 basis points margin expansion led by offshore shift and no wage hikes.

According to Nomura Equity Research, the IT industry will witness revenue growth of 2% to 8% in the first quarter of 2012, and decline in margins due to impact of wage hike, with the exception of HCL Tech. The factors which lead to this performance include the impact of macroeconomic deterioration on demand and the outlook for Indian IT companies; shifting of client spending priorities toward discretionary spending; continuation of positive pricing momentum; and the impact of an increase in visa rejections on revenue growth and margins.

Overall, as per the estimates/projections of leading broking houses, we can expect the news from the IT sector to cheer investors over 2011-12.