BSE’s IT sector index reflects road to recovery

BSE’s IT sector index reflects road to recovery

Mumbai: Buoyed by hopes of a recovery in demand for information technology (IT) services, Indian IT stocks have surged since the start of the last earnings season, or 10 July, prompting institutional investors and brokerages to revise their ratings from “reduce" and “sell" to “neutral" and “buy" with higher price targets.

The renewed interest in IT counters can be gauged from the gains in the Bombay Stock Exchange’s sectoral index, BSE-IT, which has outpaced the benchmark Sensex index.

The sectoral index has gained 37.6% since 10 July while the Sensex has risen only 22% over the same period. Collectively, companies in the BSE-IT have gained Rs1.19 trillion in market capitalization, or 42.2%, between 10 July and 15 September.

Analysts and industry executives say that while the worst seems to be over for the IT sector, the buoyancy reflects not current growth, but hopes of growth, however weak, two or three quarters down the line.

“(The) current market rally in the IT stocks may be a little ahead of consensus, but it is clear that the worst is behind us," said Tarun Sisodia, director (research) at Mumbai-based institutional investment firm Anand Rathi Financial Services Ltd, which has a “buy" recommendation on all companies in the BSE-IT index.

Surjeet Singh, chief financial officer (CFO) of Patni Computer Systems Ltd, expects a recovery in IT demand only in the middle of 2010.

However, he said that earnings growth rates of Indian IT firms may halve from the 35% levels seen in the past because of the large changes in the banking and financial services industry in the US, which had driven much of that growth. Many US financial firms collapsed, merged or were taken over by the government during the turmoil in the US banking industry.

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The fundamentals for IT firms haven’t changed much yet, analysts said. Sales revenue at top Indian IT services firms Tata Consultancy Services Ltd (TCS), Wipro Technologies and Infosys Technologies Ltd has been either falling or changed little since the quarter ended December 2008 through the one ended 30 June.

Some analysts at foreign institutional investment banks such as BNP Paribas continue to be conservative, especially when it comes to large-cap firms such as TCS, Infosys and Wipro, as their stock “valuations are already more than adequately factoring in their market share resilience and cost management advantages".

However, profit margins at most large IT firms have improved, largely because of drastic cuts in hiring or, in some instances, letting go of people, besides improving efficiency.

“Price reductions (billing rate negotiations) as well as volume declines (new work volumes) have stopped and the companies have become leaner and more efficient, so more poised to take advantage of growth when it happens. Our thinking is to get in before that growth phase begins," Sisodia said.

Nomura Financial Advisory and Securities (India) Pvt. Ltd has upgraded its rating on India’s IT sector to “neutral" from the previous “bearish" and given a “buy" recommendation for three of the top five IT services firms, revised from an earlier “reduce" or “neutral".

Nomura believes that the US economy is on a recovery path, which will lead to “slow and steady recovery in volume growth (for the IT services companies), evidenced by an increased number of deals and deal closures", analysts Harmendra Gandhi and Pinku Pappan wrote in a 10 September note to clients.

However, they added that they “do not expect a strong or quick global recovery—rather, a prolonged period of weak growth". Gandhi and Pappan wrote they expeced IT budgets for 2010 “to be flat or slightly down versus cuts of 10-20% seen in 2009 IT budgets".

Infosys, India’s second largest software services exporter, expects IT spending by its clients to be flat in 2010 from the previous year, chief executive officer S. Gopalakrishnan said on Tuesday.

At the same time, IT firms themselves have begun to send out signals that prospects are improving.

“We see good traction in terms of deal pipeline both in US and in Europe. In the US, we are starting to see a semblance of stability in the markets," said Manish Dugar, CFO of Wipro Technologies, in an email, adding that recovery would be “gradual".

Part of the slow recovery is attributable to a lack of new deals and past price renegotiations by clients.

“Though price negotiations are less frequent now than earlier, pricing pressure is expected to continue till we see more stability in the macroeconomic environment," said Dugar.

Senior HCL Technologies Ltd management, at a meeting with analysts from the investment research and analysis wing of Citigroup Global Markets Inc., “highlighted the correlation of Indian IT Services growth with S&P 500 revenues and this suggests that there could be a pick up mid-CY10 (calendar year 2010) onwards", according to Citigroup Inc. analysts Surendra Goyal and Vishal Agarwal.

The assessment of the timing is backed by industry observers like Zinnov Management Consulting Pvt. Ltd, an IT outsourcing consultancy firm.

“Even as deal closures have become shorter than it was in February, we believe it will be at least March 2010 before we see a trend of demand recovery," said Karthik Ananth, engagement manager at Zinnov. “We expect the IT budgets to remain flat for the rest of calendar year 2009."

However, industry analysts say that there appears to be increased willingness on the part of clients to discuss new projects, or what the outsourcing firms refer to as deal pipeline.

“Are deals happening in a significant way? Not yet. But yes, discussions are happening," said Sudin Apte, senior analyst at technology and market research firm Forrester Research Inc.

Technology research firm Gartner Inc., which surveyed 900 chief information officers globally, said in a report that global recovery in IT spending is expected to start between the first and third quarters of 2010.

“Hiring and hikes are back in the terminology used by outsourcing firms and is a clear indication that they are seeing indications of things looking up," said Diptarup Chakraborti, principal research analyst at Gartner. “Sectors like BFSI (banking, financial services and insurance) and retail, which had taken a severe drubbing in the aftermath of (the) financial meltdown, are showing back on the global sourcing map, (a) key sign that things are looking up."

TCS, India’s largest IT services firm by revenue, on Tuesday said it would hire 1,500 people in the current quarter for training and subsequent absorption. The hires will be from among the 25,000-odd people to whom it sent offer letters in early 2008, months before the financial meltdown in the US. TCS is also hiring 250 freshers at its Cincinnati centre in the US.

Ajoy Mukherjee, TCS’ global human resources head, said the company had officially lifted its hold on pay hikes and promotions. Last week, Wipro had also said it was lifting the hold on promotions and pay increases.

According to Chakraborti, another positive trend which had been expected was that “smaller companies in the US and Europe, typically those with 2,000 to 3,000 employees, which weren’t earlier outsourcing much, have now started discussing such options to improve their cost structures and survive in the current market".

Graphics by Ahmed Raza Khan / Mint