BackMarket seems to have little doubt of IT turnaround story
Market seems to have little doubt of IT turnaround story
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Valuations have risen from under 10 times trailing earnings to about 17 times earnings for the IT index. Since the election results, IT shares have risen 19%, almost mimicking the 20% return of the Nifty index. IT companies gain far little from a stable government compared with other companies that derive most of the revenues from within the country. So it’s a tad surprising that valuations have risen as much as the entire market in the past four months. The fact that the rupee has appreciated by 6% in the past four months also seems to have been ignored by the markets. While it’s true that things have begun to stabilize in the global economy, it’s not clear if IT companies would still have to concede price cuts to customers or that volume growth would pick up soon.
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In fact, it would come as a pleasant surprise if companies such as Infosys Technologies Ltd revise their annual guidance targets upwards in constant currency terms.
According to Citigroup Inc., Infosys is unlikely to raise its constant currency guidance partly because “it’s too early to extrapolate the improvement in sentiment to the full year guidance".
Based on news reports, it does seem likely that the finance minister would extend the sunset clause by at least another year. According to the current policy, IT companies needn’t pay taxes on profit generated in STPI units until completing 10 years of operations or until March 2010, whichever is earlier. As a result, tax rates for large companies are expected to rise from about 18% in 2009-10 to roughly 22% in 2010-11.
Consensus earnings estimates for large IT companies currently factor a similar rise in tax rates. So if the sunset clause is indeed extended, it should come as a positive surprise. But according to a note by Citigroup, for some large companies such as Infosys and Wipro, the benefit would not be much since most of their centres are already out of STPI. This is because most of these companies’ STPI centres have already completed 10 years of operations.
But it notes that the move would make a big difference to TCS’ tax rates in FY11 and that HCL would also benefit marginally.
In other words, investors shouldn’t buy IT stocks en masse if the STPI sunset clause is extended. In any case, with valuations already having risen sharply, it’s time some caution is exercised.
Write to us at marktomarket@livemint.com
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