Optimism in Indian IT stocks is premature

Optimism in Indian IT stocks is premature
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First Published: Wed, May 06 2009. 10 18 PM IST

Updated: Wed, May 06 2009. 10 18 PM IST
Shares of Indian information technology, or IT, vendors corrected on Wednesday, despite the impressive results and guidance of Cognizant Technology Solutions Corp. As pointed out in this column yesterday, the US-headquartered Cognizant is treading a different path in the current downturn thanks to the closer proximity it enjoys with its major clients. The company expects revenue to grow by 10% in 2009, at a time when most India-based IT vendors are expected to report a decline in revenues.
It’s heartening to note that the markets didn’t get carried away with Cognizant’s impressive results and jump to the conclusion that all IT firms will do as well this year. As it is, large IT stocks have gained between 37% and 83% from their lows in March without any significant change in business fundamentals. These firms trade at valuations of 12-15 times trailing earnings, hardly justifiable for companies whose earnings are expected to decline this year. Brokers such as IIFL Cap and CLSA are factoring in earnings growth in fiscal year 2010-11, but expect earnings to be only marginally higher than the levels in FY09. The compounded annual growth rate (CAGR) of earnings in the coming two years is estimated to be flat, based on the estimates of these two brokers.
Of course, some others such as JP Morgan feel that the IT outsourcing business has bottomed out and there will be a sharp recovery from the second half of the current fiscal year. It expects earnings to grow at a CAGR of between 7% and 12% for the top three IT firms. But this is an extremely positive view, not only relative to consensus estimates, but also considering the fact that nothing much has changed on the ground in recent times.
IIFL Cap states in a recent report that its channel checks indicate no visible improvement in the deal pipeline and that project non-renewals are continuing. Besides, company managements themselves haven’t ruled out further pricing and volume pressures in their commentary after announcing March quarter results. While Indian companies are expected to benefit from a weak rupee, margin gains are likely to be limited because of pricing pressure. Besides, large firms such as Tata Consultancy Services Ltd and Infosys Technologies Ltd have made large commitments in terms of hiring freshers and employee utilization is expected to fall further this year.
And as if the woes of Indian IT firms weren’t enough, there’s a fresh wave of protectionism in the US under the new president. It seems premature to ignore these negatives and instead turn optimistic about what the future holds.
Write to us at marktomarket@livemint.com
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First Published: Wed, May 06 2009. 10 18 PM IST