Bangalore: Major Indian software services companies have smashed estimates in their April-June earnings, but are cautious in their near-term forecasts due to uncertainty about a revival in technology spending by global firms.
Shares in Tata Consultancy Services Ltd, Infosys Technologies Ltd and Wipro Ltd, the top three outsourcing firms, have risen between 80-103% this year, compared to a 60% rise in the main Mumbai market. Is there still upside left to the shares or the rally is all set to ebb due to uncertainty about near-term business growth?
More Steam Left
Bulls say signs of some stability in global financial sector augurs well for the Indian outsourcers, whose clients include Citi, Goldman Sachs and Credit Suisse. Infosys and Tata Consultancy are expanding in markets such as Latin America, Europe and Asia to boost growth and reduce their focus on the US, which brings in more than half their revenue.
“The worst for these companies is clearly behind us,” said Tarun Sisodia, an analyst with Anand Rathi Financial Services. “People have factored in flatish to positive growth in this year, but the whole of next year will be significantly better.”
Sisodia upgraded Infosys and Tata to buy from sell after the June quarter earnings and has a 12-month price target 32% above the current level for Infosys and 54% for Tata.
“We are at the cusp of an upgrade cycle... these stocks will definitely outperform the market,” he said. “There is more steam left in IT companies.” K.K. Mital, head of portfolio management services at Globe Capital, said demand for IT stocks rose after the firms reported better-than-expected profit margins in their quarterly earnings and said pricing pressure had eased. “We are of the view that the business has stabilised,” said Mital, who holds Infosys in his portfolio. “There are new client additions happening for the companies and cost reductions and restructuring of some operations are also positive for growth.”
Others say current prices assume too much.
“You will not see rapid growth coming back to the sector anytime soon. You can’t rule out another Lehman happening in the near future and if that happens all their clients will again go back into a shell,” said Srivathsan Ramachandran, a sector analyst with Spark Capital Advisors.
“It will take quite some time before the pricing power for Indian IT firms return to the pre-downturn levels. The assumption that the companies will be able to repeat their performance of June quarter in the remaining three quarters of this year is on the riskier side.”
Tata and Wipro trade at 17 times their 1-year forward price earnings ratio, while Infosys trades at 19 times. IBM and Accenture, their bigger rivals, trade at about 12 times.
“In my judgement to carry the valuation multiples much further we are going to have to get evidence that volumes and pricing are actually picking up and I am not sensing that yet,” said Karl Keirstead, an analyst with Kaufman Bro. in New York. “If you are going to pay 20-25 times for the Indian firms you have to believe that over the next 2-3 years the growth rate for this industry can recover back to 20 to 30%, and there are many reasons why that will be difficult,” Keirstead said.
“I think Accenture can outperform the equity markets because Accenture is better positioned, they have a broader service offerings, they are less risky bets,” he said.
Sam Mahtani, who manages $350 million at F&C’s Indian Investment Company in London, said: “The sector looks fair valued at the moment. We think there are better opportunities in other areas, particularly in infrastructure sector.”