You are on page 1of 7

India I Equities

IT Services Sector Update

11 October 2010

India IT Services
Sep 10 preview Recovery still to be volume-led

Nifty: 6145 Sensex: 20250

Sep 10 quarter preview. We expect the top-6 IT Services companies to register 7.5% qoq rise in revenue (4-8% in US dollar terms) and 6.7% rise in net profit. Margins would be flattish sequentially, with a 10-bps dip (mixed trend for our top-6 coverage universe), primarily owing to wage hikes for HCL Tech and Wipro as well as promotions for TCS. For the Sep-ending quarter, the average rupee/US dollar conversion rate stood at 46.5 versus 45.7 in Jun-ending quarter. Tech Mahindra would gain the most owing to its greater billing in the GBP and Euro. Key trends for Sep-ending quarter. We believe pricing stability would sustain, with upward bias due to favourable cross-currency movements. Volumes for the quarter would be robust, with 4-7% sequential volume increase for the top-6 IT Services companies. We expect Infosys FY11 (US dollar) revenue guidance to be upgraded to 21-23%; it is likely to raise its FY11 EPS guidance to `116-120/share. Expect optimistic outlook. We expect IT Services companies to be optimistic as regards macro environment. Focus would be on IT discretionary spending trends and supply-side management (hiring, laterals and attrition). Factors to watch. Increased focus on fixed-price contracts, pricing pressure, client additions, client mining, revenues from IMS and BPO and cost-curtailment measures, besides other P&L items.
Sales (`m) YoY chg (%) QoQ chg (%) Net profit (`m) YoY chg (%) QoQ chg (%)

Naushil Shah
+9122 6626 6708 naushilshah@rathi.com

Atul Thakkar
+9122 6626 6724 atulthakkar@rathi.com

Company

Target (`)

Rating

TCS Infosys Wipro HCL Tech MphasiS Tech Mahindra Patni Core Projects Rolta India Infotech Enterprises Polaris Software Persistent Allied Digital
Source: Anand Rathi Research

920 2930 510 425 780 800 550 325 220 175 235 515 325

Hold Hold Buy Buy Buy Hold Hold Buy Hold Sell Buy Hold Buy

IT Sector, Sep '10 quarter forecasts


Company

BSE IT vs Sensex

TCS Infosys Wipro HCL Tech MphasiS Tech Mahindra IT sector (top six) Patni Core Projects Rolta India Infotech Enterprises Polaris Software Persistent Allied Digital
Source: Anand Rathi Research

88,944 67,929 77,420 35,718 13,314 12,103 295,429 8,109 2,664 4,233 2,697 3,821 1,896 2,154

19.6 21.6 11.9 17.8 17.6 6.0 17.0 0.9 32.7 20.8 13.6 12.9 29.4

8.2 9.6 7.0 4.3 4.1 6.8 7.5 4.3 21.1 2.7 6.7 6.0 4.7 6.3

20,057 17,271 13,193 3,117 2,525 1,518 57,680 1,243 531 642 336 489 327 354

23.5 12.2 10.4 (2.6) 3.1 (10.2) 13.3 (27.5) 43.7 14.5 (4.8) 38.8 41.1

8.8 16.1 0.1 (8.8) (6.9) 5.1 6.7 (15.6) 22.7 (7.1) 2.2 4.8 (5.4) 6.8

150 140 130 120 110 100 Sensex 90 Mar-10 Apr-10 May-10 Feb-10 Nov-09 Dec-09 Jan-10 Jun-10 Jul-10 Oct-09 Aug-10 Sep-10 Oct-10 BSE IT

Source: Capitaline

Anand Rathi Financial Services, its affiliates and subsidiaries, do and seek to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1. Anand Rathi Research India Equities

11 October 2010

IT Services: Sep 10 preview Recovery still to be volume-led

Fig 1 IT sector: Sep 10 quarter preview


Company Bloomberg code Price* (`) Market cap (US$m) Sales (`m) YoY (%) QoQ (%) EBITDA margin (%) YoY (bps) QoQ (bps)

PAT (`m) 20,057 17,271 13,193 3,117 2,525 1,518 1,243 531 642 336 489 327 354 61,275 57,680

YoY (%) 23.5 12.2 10.4 (2.6) 3.1 (10.2) (27.5) 43.7 14.5 (4.8) 38.8 41.1 12.4 13.3

QoQ (%) 8.8 16.1 0.1 (8.8) (6.9) 5.1 (15.6) 22.7 (7.1) 2.2 4.8 (5.4) 6.8 6.0 6.7
rd

Result date 21-Oct 15-Oct 22-Oct 20-Oct 22-Nov 3 week of Oct 27-Oct Last week of Oct 25-Oct 14-Oct 19-Oct 21-Oct Last week of Oct

TCS Infosys Wipro HCL Tech MphasiS Tech Mahindra Patni Core Projects Rolta India Infotech Enterprises Polaris Software Persistent Allied Digital IT Sector** IT Sector (Top 6)

TCS IN Equity INFO IN Equity WPRO IN Equity HCLT IN Equity MPHL IN Equity TECHM IN Equity PATNI IN Equity CPTL IN Equity RLTA IN Equity INFTC IN Equity POL IN Equity PSYS IN Equity ALDS IN Equity

942 3,077 462 433 660 766 438 294 169 165 172 433 243

41,572 39,817 25,516 6,627 3,123 2,143 1,283 802 614 413 388 391 263

88,944 67,929 77,420 35,718 13,314 12,103 8,109 2,664 4,233 2,697 3,821 1,896 2,154 319,108 295,429

19.6 21.6 11.9 17.8 17.6 6.0 0.9 32.7 20.8 13.6 12.9 29.4 16.7 17.0

8.2 9.6 7.0 4.3 4.1 6.8 4.3 21.1 2.7 6.7 6.0 4.7 6.3 7.4 7.5

29.1 33.3 22.0 16.5 23.4 19.1 18.8 32.2 36.8 17.5 15.5 19.8 22.0 25.8 26.0

38 (132) (10) (622) (260) (653) (118) 42 100 (419) (42) 173 (113) (121)

(23) 163 (65) (212) (128) 32 (1) (410) (205) 151 213 83 120 (10) (10)

*Prices as on 8 Oct 10 **calculation does not include Persistent Source: Bloomberg, Anand Rathi Research

Anand Rathi Research

11 October 2010

IT Services: Sep 10 preview Recovery still to be volume-led

Quarterly preview
Pricing is likely to be stable, with a positive bias on account of favourable cross-currency movements. After their robust 1QFY11 earnings, IT companies volume growth would be 4-7%. Our top-six IT companies are expected to post a 7.5% rise in revenues sequentially, with net profit increasing 6.7%. Pricing Stable; favourable cross-currency movements We expect flattish pricing over the previous quarter. In line with this expectation, we have factored in a flattish pricing-rate assumption across the board, with a slight uptick to account for the favourable sequential crosscurrency movements. We await management comments on the issue before re-visiting our pricing views. Volumes To lead the path to recovery On the volume front, we have factored in sequential increases for Infosys, TCS and Wipro due to better traction among their present and new clients, HCL Tech (due to aggressive pricing) and MphasiS (strong pipeline support from parent and other clients). Our view is that volume growth would lead the demand-recovery cycle. Further, traction from existing clients has improved. Guidance expectations for Infosys We expect Infosys to upgrade its FY11e US$ revenue guidance to 21-23% (from 19-21% given during 1QFY11 results). Further, for the September quarter, the rupee averaged `46.5 to the US dollar (at end-quarter, it was `44.95). FY11 rupee-based guidance would now be based on the rupee conversion rate at end-quarter (3.2% rupee appreciation from end-June) and we expect Infosys to raise its FY11e EPS guidance to `116-120.

Anand Rathi Research

11 October 2010

IT Services: Sep 10 preview Recovery still to be volume-led

IT Companies Key trends for the Sep 10 ending quarter


Fig 2 Company-specific comments
Revenue (US$m) Jun 10 Sep 10 QoQ (%) Expectations

Infosys

1,358

1,461

7.6

TCS

1,794

1,913

6.6

Wipro IT

1,204

1,273

5.8

HCL Tech Tech Mahindra

738 251

787 260

6.7 3.6

MphasiS*

276

286

3.9

Pricing increase of 0.2%, volume increase of 7.3%, qoq, EBITDA margin increase of 163bps on account of favourable currency movement and wage hikes being completed in 1QFY11. In rupee terms, we expect sequential increase of 9.6% in revenue. Pricing increase of 0.3%, volume increase of 6.2% sequentially; EBITDA margin decline of 23bps on account of promotions in the quarter. In rupee terms, we expect sequential increase of 8.2% in revenue Pricing increase of 0.3%, volume increase of 5.4% qoq, EBITDA margin decrease of 60bps. In rupee terms, we expect revenue to increase 7%. We expect the IT products business to grow 6% qoq, while consumer care is expected to show a sequential 7% growth. Flat pricing, blended volume increase of 6.6% qoq, BPO expected to slid 6% qoq In rupee terms, we expect revenue to increase 4.3% EBITDA margin increase of 30bps sequentially. In rupee terms, we expect revenue increase of 6.8%, since ~48% of Tech Mahindra's revenue is invoiced in GBP, which has moved favourably qoq for Tech Mahindra this quarter. Flat pricing, 4% increase in volumes on account of healthy traction from parent HP-EDS, non HP-EDS clients. EBITDA margin decline of 128bps In rupee terms and revenue increase of 4.1% Pricing increase of 0.2%, 6.3% increase in volumes. EBITDA margin to be flat. In rupee terms, we expect revenue to increase 4.3%. PAT expected to be lower on account of lower other income (treasury) Flat billing rates sequentially; 37.6% yoy growth to come from the domestic market due to consolidation of Laser Soft from Nov 09. In rupee terms, we expect revenue to increase 6.7%. EBITDA margin expected to increase 150bps qoq due to favourable currency and complete salary increase absorption in 1Q. We expect flat billing rates across both the UTG and EMI segments. In rupee terms, we expect revenue to increase 2.7% on account of healthy traction in the geospatial space. EBITDA margin decline of 205bps qoq on account of salary hikes. We expect 1% billing-rates increase qoq. US$13m is expected to come from EPGS; expect margins to be at 22% mainly due to offshoring of EPGS business. EBITDA margin expected to be 32.2%, a 410-bps sequential decline. In rupee terms, we expect revenue to increase 4.7%. EBITDA margin expected to increase 83bps qoq due to favourable currency and complete salary increase absorption in 1Q. We expect flat billing rates.

Patni

168

179

6.6

Polaris Infotech Enterprises

79 55

82 58

4.1 4.7

Rolta India

88

93

5.2

Allied Digital 2,026 (`) Core Projects 2,201 (`) Persistent 39

2,154 2,664 41

6.3 21.1 3.2

* Estimates for MphasiS are for quarters ending Jul 10 and Oct 10 respectively Source: Company, Anand Rathi Research

Currency 1.8% sequential rupee depreciation against the US dollar For the Sep 10-ending quarter, INR/USD conversion has averaged 46.5. For the Jun 10-ending quarter, average conversion rates stood at 45.6 for Infosys, 45.8 for TCS, 46.7 for Wipro, 46.4 for HCL Tech, 45.1 for Tech Mahindra, 46.4 for MphasiS (Jul 10-ending quarter) and 46.4 for Patni. Wipro, HCL Tech, MphasiS and Patni are likely to benefit the least, even after sequential rupee depreciation; on the other hand, Tech Mahindra, Infosys and TCS would gain. We have not accounted for cross-currency movements and the hedging-book impact.

Anand Rathi Research

11 October 2010

IT Services: Sep 10 preview Recovery still to be volume-led

Cross-currency movements Favourable for 2QFY11 In 1QFY11, IT companies were hurt 1-3% due to unfavourable crosscurrency movements. We expect 2QFY11 cross-currency movements to be favourable for revenues in US dollar terms (1-3%), with Infosys gaining the least and Tech Mahindra the most. Figs 3 & 4 show movements of various currencies against the US dollar & rupee respectively and demonstrate that Tech Mahindra, which has greater exposure to billing in GBP and Euro, would gain the most.
Fig 3 Quarterly average currency movements
USD/GBP USD/Euro Yen/USD USD/AUD INR/USD

30 Sep 10 30 Jun 10 30 Sep 09 % change (qoq) % change (yoy)


Source: Bloomberg

1.6 1.5 1.6 3.9 (5.5)

1.3 1.3 1.4 1.6 (9.6)

85.7 92.0 93.6 7.3 9.1

0.9 0.9 0.8 2.6 8.6

46.5 45.7 48.4 1.8 (3.9)

Fig 4 Rupee movement vis--vis other currencies


INR/GBP INR/Euro INR/Yen INR/AUD INR/USD

30 Sep 10 30 Jun 10 30 Sep 09 % change (qoq) % change (yoy)


Source: Bloomberg

72.1 68.2 79.4 5.8 (9.2)

60.1 58.1 69.2 3.4 (13.1)

0.5 0.5 0.5 (8.5) (4.6)

42.1 40.3 40.4 4.4 4.3

46.5 45.7 48.4 1.8 (3.9)

Fig 5 shows currency exposure of companies. Tech Mahindra is the largest gainer from cross-currency movements as it has most exposure to billing in GBP terms. Infosys would gain the least on account of its lower exposure to the GBP and the Euro.
Fig 5 Share of invoices in various currencies, %
Cross-currency impact USD GBP Euro Others USD reporting INR reporting

TCS Infosys Wipro HCL Tech Tech Mahindra

60.0 74.8 65.0 58.0 30.0

14.0 6.8 12.0 18.5 48.0

8.0 6.0 8.0 8.5 8.0

18.0 12.4 15.0 15.0 14.0

1.4 0.7 1.2 1.5 2.3

1.7 1.2 1.4 1.8 2.8

Only Infosys provides shares of invoices on a quarterly basis; all other figures are approximations based on discussions; others include AUD, Yen and INR Source: Company, Anand Rathi Research

Hedging MTM losses to dent due to 1.8% sequential rupee depreciation In other income TCS and Infosys would tend to lose the least from rupee depreciation on account of low hedges (US$653m and US$700m respectively). Wipro (US$2.3bn), Tech Mahindra (US$1.1bn), MphasiS (US$564m), are likely to see losses marked in their P&Ls (under other income). Nevertheless, their losses could vary on account of the differing rates at which such hedges have been booked.

Anand Rathi Research

11 October 2010

IT Services: Sep 10 preview Recovery still to be volume-led

Fig 6 Hedging details


Company Hedge book Hedge rate (INR/USD) No. of quarters Comments

MphasiS Infosys

US$564m US$700m

47.50-48 ~42

2.0 x 4QFY10 0.5 x 2QFY11

TCS Wipro HCL Tech

US$653m

41-42

0.3 x 2QFY11 1.3 x 2QFY11 0.5 x 1QFY11 4.1 x 2QFY11 2.2 x 3QFY10

US$2,257m 39.50-51.50 US$362m 41

Tech Mahindra US$1,063m ~45 Patni US$398m ~48

Increased hedges from a 1QFY08 low of US$5m Lowered hedges from a 2QFY08 peak of US$1.3bn, while they increased by US$286m in the last quarter Lowered hedges from a 4QFY08 peak of US$4.5bn Lowered hedges from a 4QFY08 peak of US$3.7bn Lowered hedges from a 3QFY08 peak of US$2.7bn Lowered hedges from a 1QFY09 peak of US$1.5bn Increased hedges from a 3QFY09 low of US$287m

Source: Company, Anand Rathi Research

Key trends Operating parameters In our report Macro meltdown blues; Initiate at Underweight; Sell INFY dated 17 Nov 08, we had mentioned companies increasingly shifting from the time and material (T&M) model to a fixed-price project (FPP) model (Fig 7). We believe the trend would sustain as it provides Indian IT companies with better margins on efficiently executed projects.
Fig 7 Fixed-price revenue
% of revenue Fixed-price revenue 2QFY09 35.7 3QFY09 37.9 4QFY09 39.5 1QFY10 39.8 2QFY10 40.6 3QFY10 41.4 4QFY10 42.3 1QFY11 42.5

Infosys TCS Wipro HCL Tech MphasiS Patni

34.1 43.4 31.6 36.0 4.9 36.8

36.3 45.5 36.0 36.2 6.4 37.8

38.3 47.1 38.1 37.6 8.2 37.6

38.1 47.4 38.4 38.5 8.9 39.8

38.0 47.2 40.3 40.0 12.5 42.4

38.3 48.0 42.5 39.6 13.4 42.4

39.5 48.7 44.3 40.5 10.3 43.6

39.0 49.1 44.6 40.9 11.0 43.1

Source: Company, Anand Rathi Research

In our report, we had also stated that IMS revenues would grow faster than other horizontals in these turbulent times (Fig 8); we maintain our view.
Fig 8 IMS revenue
% of revenue IMS 2QFY09 10.5 3QFY09 11.2 4QFY09 11.7 1QFY10 12.4 2QFY10 12.4 3QFY10 12.4 4QFY10 12.9 1QFY11 13.1

Infosys TCS Wipro HCL Tech MphasiS Patni

5.9 7.5 19.5 15.7 8.0 4.7

6.5 8.3 19.4 16.5 10.2 5.0

7.0 8.3 20.9 15.1 13.3 3.5

6.6 9.3 20.9 17.6 14.4 4.7

7.8 8.0 20.6 19.4 13.7 6.0

7.1 7.9 21.3 20.3 11.4 5.3

7.2 8.3 21.6 22.2 12.8 5.0

6.9 8.7 21.1 22.4 17.9 5.4

Source: Company, Anand Rathi Research

Anand Rathi Research

Appendix 1
Analyst Certification The views expressed in this research report accurately reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the research analyst(s) was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. The research analysts, strategists, or research associates principally responsible for the preparation of Anand Rathi Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues. Anand Rathi Ratings Definitions Analysts ratings and the corresponding expected returns take into account our definitions of Large Caps (>US$1bn) and Mid/Small Caps (<US$1bn) as described in the Ratings Table below. Ratings Guide Large Caps (>US$1bn) Mid/Small Caps (<US$1bn) Buy >20% >30% Hold 5-20% 10-30% Sell <5% <10%

Anand Rathi Research Ratings Distribution (as of 20 July 10) Buy Anand Rathi Research stock coverage (114) 66% % who are investment banking clients 8%

Hold 14% 0%

Sell 20% 0%

Other Disclosures This report has been issued by Anand Rathi Financial Services Limited (ARFSL), which is regulated by SEBI. The information herein was obtained from various sources; we do not guarantee its accuracy or completeness. Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities or any options, futures or other derivatives related to such securities ("related investments"). ARFSL and its affiliates may trade for their own accounts as market maker / jobber and/or arbitrageur in any securities of this issuer(s) or in related investments, and may be on the opposite side of public orders. ARFSL, its affiliates, directors, officers, and employees may have a long or short position in any securities of this issuer(s) or in related investments. ARFSL or its affiliates may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this report. This research report is prepared for private circulation. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each security's price or value may rise or fall. Past performance is not necessarily a guide to future performance. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. This document is intended only for professional investors as defined under the relevant laws of Hong Kong and is not intended for the public in Hong Kong. The contents of this document have not been reviewed by any regulatory authority in Hong Kong. No action has been taken in Hong Kong to permit the distribution of this document. This document is distributed on a confidential basis. This document may not be reproduced in any form or transmitted to any person other than the person to whom it is addressed. If this report is made available in Hong Kong by, or on behalf of, Anand Rathi Financial Services (HK) Limited., it is attributable to Anand Rathi Financial Services (HK) Limited., Unit 1211, Bank of America Tower, 12 Harcourt Road, Central, Hong Kong. Anand Rathi Financial Services (HK) Limited. is regulated by the Hong Kong Securities and Futures Commission. Anand Rathi Financial Services Limited and Anand Rathi Share & Stock Brokers Limited are members of The Stock Exchange, Mumbai, and the National Stock Exchange of India. 2010 Anand Rathi Financial Services Limited. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Anand Rathi Financial Services Limited. Additional information on recommended securities/instruments is available on request.