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Top four Indian IT firms to grow this quarter as demand improves

Top four Indian IT firms to grow this quarter as demand improves
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First Published: Wed, May 12 2010. 09 33 PM IST

Updated: Wed, May 12 2010. 09 33 PM IST
We remain positive on the demand environment for Indian information technology (IT) services companies, barring short-term concern on margins due to increased attrition and wage inflation. Infosys Technologies Ltd and Tata Consultancy Services Ltd (TCS) are our top picks in the sector, with a target price of Rs3,250 and Rs990, 24 times estimated FY12 earnings, respectively.
The top four IT services companies grew their dollar revenue by 4% sequentially (5.5% at constant currency) led by Infosys (sequentially 5.2%, 6.1% at constant currency) and followed by HCL Technologies Ltd (sequentially 5.1% and 6.9% at constant currency), Wipro Ltd (sequentially 3.5% and 4.7% at constant currency) and TCS (4.2% at constant currency). We believe that the volume momentum for the large-caps is likely to continue in the mid single digit.
Also See Strong Growth (Graphic)
Wage hikes doled out by the Indian IT companies were in line with our expectation. We anticipated a hike of 10-13%, whereas the companies have given wage hikes in the range of 8-17%, with Infosys (offshore 14% on average, onsite 2.5% on average) giving the highest wage hike. We believe that a sudden rise in attrition (16-20% annualized) has pushed Indian IT companies to give higher-than-anticipated wage hikes.
We expect attrition to come down in the next two quarters. High attrition (due to higher general and administrative cost) and wage inflation will erode margins in the near term, but indicates a strong deal pipeline.
Continued growth momentum in “package implementation and consulting” reaffirms our hypothesis that discretionary spend is coming back. We expect realization improvement to start kicking in by the second half of FY10. TCS’, Cognizant Technology Solutions Ltd’s and Capgemini’s managements have given early indication of realization improvement in the second half of FY11 in line with our hypothesis.
We believe that growth in package implementation and consulting for the top four is an early indication of the onset of discretionary spends. We believe that growth in package implementation is attributed to: enterprise resource planing (ERP) and customer relation management (CRM) integration of merged and acquired entities (largely banking, financial services and insurance), reduced cost and improved competitiveness using CRM and ERP software, pent-up demand. Revenue contribution from package implementation declined earlier than licence sales for SAP and Oracle, indicating deferred implementation plans.
Hence, the pent-up demand would continue to derive growth for the vertical for the next two to three quarters.
We believe that the current crisis in Europe will stretch the sales cycle further and make the recovery process slow. We anticipate that the austerity measures taken by the companies and governments in Europe would give a boost and more acceptability to the outsourcing industry.
Cognizant revised FY10 revenue outlook to “at least 25%” from “at least 20%” compared with a consensus of 22%. Moreover, the second quarter revenue guide implies 5.8%-plus sequential growth. The management said that “a robust pipeline of growth opportunities” and “an improving pricing environment” will help offset expected wage increases which should also be received positively in line with our hypothesis.
We believe that the quarter will be solid with some upside to our 4% revenue estimate for Infosys. We think that Infosys and TCS are poised to deliver mid 20s dollar-term growth and have got the least exposure to Europe among peers. We reiterate our accumulate recommendation on Wipro and HCL.
Graphic by Yogesh Kumar/Mint
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First Published: Wed, May 12 2010. 09 33 PM IST
More Topics: India | IT firms | Demand | Infosys Technologies | TCS |