In the past one month, information technology (IT) stocks have outperformed the broader markets by about 10%. Although hopes that governments in Europe will tackle the region’s debt woes seem to have waned, IT stocks have continued to do well because of the sharp depreciation of the rupee. Since end-August, the rupee has fallen by around 7.5% against the dollar.
During the same time, concerns about the global economy have grown, which also means the outlook for IT services demand in the medium term has become weaker. Investors, however, seem to have concluded that companies will be net gainers in the process.
Nevertheless, the fact that these companies will be reporting September quarter results in this backdrop means they have little room for error. Most analysts are expecting top-tier companies to grow revenues by 5-6% quarter-on-quarter in dollar terms (of course, this excludes Wipro Ltd, which is expected to grow organically by a lower 1-2%, as it is still to return to a steady state of operations).
While this looks like a decent rate of growth, note that top-tier firms had grown revenues by nearly 10% quarter-on-quarter in the year-ago September quarter. The second quarter of the fiscal is a seasonally strong quarter for IT companies, and 5-6% growth wouldn’t exactly set their share prices on fire. Needless to say, if these companies report growth that is materially higher than the estimated levels, stocks can be expected to react positively.
But few analysts are betting on that. Most industry observers are concerned about the outlook for 2012 and customers’ IT budgets for the next year. It’s unlikely, however, that IT vendors will already have clarity on that and one would have to wait until the December quarter results announcement for more details on IT budgets for 2012.
In the September quarter, meanwhile, companies will benefit from the depreciation of the rupee and are expected to report better margins. For some companies such as Tata Consultancy Services Ltd and Wipro, where forex hedges are relatively higher, hedging losses will offset at least some of the gains in profitability. Infosys Ltd, the only top-tier company to provide an annual guidance, is likely to lower its annual revenue target in dollar terms because of the deterioration in the macro environment and unfavourable cross-currency movement. Despite that, its earnings per share guidance in rupee terms will increase considerably because of the rupee depreciation.
As pointed out earlier, these changes are unlikely to move IT stocks, since much of this is already expected. A Kotak Institutional Equities results preview report sums it up well: “Marginal outperformance is likely to be ignored by the market; however, any underperformance versus expectations would likely be punished, given the increased caution on demand outlook.”