Management of front-line information technology (IT) companies have commented positively on the demand environment. Tata Consultancy Services (TCS)’ management has hinted towards some signs of recovery in outsourcing demand especially from the banking, financial services and insurance (BFSI) vertical.
It said that the banking and finance industry across the globe is beginning to have a re-look at discretionary spend that was frozen completely after the financial meltdown. This would benefit players such as TCS (43.9%) and Infosys Technologies (Infosys; 33%) that have relatively higher exposure to the BFSI vertical.
Improved demand environment has led to improved decision-making cycle and deal closures have started taking place. In fact, front-line IT companies have been benefiting from vendor consolidation scheme. Based on deals reported in the press there has been deal flow of $2.2 billion for IT vendors in Q2FY2010. Improved decision-making cycle coupled with the pent-up demand bodes well for CY2010 IT budgets. The same also improves the revenue visibility of front-line IT companies.
Additionally, there has been increased news flow for wage hike review by front-line IT companies. While, the wage hike review provides confidence for improving the business environment, this can have negative impact on the margins of front-line IT firms. However, we believe, players such as Infosys and TCS with lower utilisation rate will be in better position to manage their margins going forward.
In Q2FY2010, front-line IT companies are also expected to benefit from favourable cross currency movement. This is likely to have positive a impact of 1.5-2% on the dollar-term revenues of front-line IT companies in Q2FY2010 enabling the companies to beat their dollar-term revenue guidance.
We have fine-tuned our FY2010 and FY2011 earnings estimates marginally for front-line IT companies. Given the improvement in demand environment and increasing deal conversion providing revenue visibility, we are now expanding our target multiple for front-line IT companies.
We are upgrading TCS to Buy recommendation on the back of better earnings compounded annual growth rate (CAGR) during FY2009-11 than its peers, the recovery in BFSI vertical, lower utilization rate providing layer for margin management and healthy deal pipeline. We maintain our HOLD recommendation on other front-line IT stocks due to limited upside at current levels.