In spite of the uncertainty in global demand for information technology companies and the weakening rupee, top companies in India are expected to maintain their investment grade ratings

Moneylife Digital Team

The top Indian information technology (IT) companies, Tata Consultancy Services (TCS), Infosys and Wipro are likely to maintain their investment-grade ratings even if demand weakens. This is according to the report that Standard & Poor's Ratings Services has recently published, Big Three Indian IT Companies Are Well Programmed To Handle Uncertain Demand. The ratings of the "Big Three" companies are TCS (TCS; BBB+/Stable/--); Infosys (BBB+/Stable/--) and Wipro (BBB/Positive/--).

“The largest Indian IT companies have strong margins, are cost-competitive, and have proven delivery models. These attributes will help them to weather uncertain and volatile demand,” said Standard & Poor’s credit analyst Abhishek Dangra.

The report suggests that the three leading Indian IT companies will be able to grow at a faster pace than the global industry, at least over the next few years. S&P expects these companies to maintain industry-leading EBITDA margins and grow in double digits in the next 12 months.

The bigger challenges for the Indian IT companies will occur in the longer term. It is expected that the cost advantages of these companies will diminish as foreign competitors increase their already-large employee bases in India. Moreover, business and reputation risk is rising due to increasing protectionism. But it is expected that the three largest Indian IT companies will adapt to the challenges, as they have in the past.

The report says that companies also face issues such as dependence on the slowing economies of the US and Europe, visa issues, rising wages in India, and foreign exchange volatility. The sovereign budget cuts across the US and Europe could hurt business sentiment and lower private-sector IT spending. Though deal cancellations are not as significant as they were in 2008-2009, the time it takes to close deals has lengthened.

“High unemployment rates, slowing growth, and political activism in many countries are generating opposition to outsourcing,” said Mr Dangra. “Still, we expect focus on cutting costs in a slowing global economy to support demand for outsourcing to India. Such a practice results in significant cost savings.”

The sluggish global economy will apply pressure on pricing for Indian IT companies on export orders. But simultaneously, the weakening rupee against the dollar and the euro will improve margins to push for a mixed outlook for these companies. TCS and Infosys have deals in the pipeline for overseas orders and are not as sharply affected by the slowing economies abroad. Customers abroad are likely to embrace new technology and TCS is likely to win high-tech orders, where pricing pressure is not severe. Wipro, which has reorganised its management this year, will face some pressure on new deals and consequently revenues. But it is expected to have a healthy bottom-line.

Hiring plans are likely to be hit in top IT companies, as they move to higher wages for existing good performers and experienced new recruits. Engineering colleges and management institutes, which have many aspiring software engineers, may be adversely affected in the forthcoming placement season in terms of number of students recruited by the IT industry.

TCS is likely to improve at a greater rate and may even outpace Infosys and Wipro. TCS recorded an average sales growth of 33% during the previous three quarters, last one ending in June 2011. Its market cap to operating profit ratio is 20.1, while its return on net worth based on annualised net profit of the past three quarters is an exceptional 51%. It has a unique Global Network Delivery Model and has 1,98,500 consultants in 42 countries.  

Lower-rung IT companies may face the pinch on pressure on pricing and consequently, profits.