Sandeep Bhatnagar/Mint

Sandeep Bhatnagar/Mint

Citi, Goldman downgrade Indian IT stocks on global headwinds

Citi, Goldman downgrade Indian IT stocks on global headwinds

Mumbai: Citigroup and Goldman Sachs on Monday lowered estimates of Indian information technology (IT) firms, slashing price targets of these stocks across the board against the backdrop of the deteriorating macroeconomic situation in the US and Europe, from where these firms earn most of their revenue.

Also See | Lowered Expectations (PDF)

While Citigroup Global Markets’ Surendra Goyal cut the price targets of the big four Indian IT firms by between 11.9% and 19.6%, Goldman Sachs Global Investment Research slashed the price targets of seven stocks by 9.8-30.7%.

Sandeep Bhatnagar/Mint

“The downgrade of US credit and the Euro zone worries have shifted investor focus to the global macro. The environment has been challenging for some time, but decision-making could get impacted due to recent events, which is one of the bigger concerns for Indian IT," Goyal said in his report, stressing that decision-making (on IT budgets) could get impacted due to the recent events.

“Given the Indian IT sector’s strong correlation with US earnings growth, we expect Indian IT companies’ growth to moderate," the report added. Citi recently cut its global growth forecast to 3.2% from 3.7% for 2012.

Citi factors in moderate volume growth with stable pricing, resulting in estimates for the next fiscal year beginning April 2012 being trimmed by 6-11%.

It has slashed the price targets of HCL to 505 from 595, Infosys to 2,570 from 3,125, TCS to 1,110 from 1,260 and Wipro to 410 from 510.

Goldman Sachs’ Balaji Prasad, Rishi Jhunjhunwala and Baneesh Banwait reduced revenue estimates for IT large caps by up to 9% for the fiscal years ending 31 March 2012 through 31 March 2014, forecasting 14% revenue growth for the next fiscal year.

“While management comments continue to reflect a stable near-term outlook, there is uncertainty on demand pipeline going into 2012. We note that historically, IT services growth lags gross domestic product by six-eight months (67% correlation). As customers start their budgeting process, a deteriorating outlook for 2012 could impact the dollar value of IT budgets," the Goldman report said.

The firm cut the price targets of HCL to 501 from 590, Infosys to 3,004 from 3,300, MphasiS Ltd to 401 from 502, Patni Computer Systems Ltd to 271 from 391, Rolta India Ltd to 115 from 166, TCS to 1,115 from 1,264 and Wipro to 390 from 444.

The gloomy outlook is already reflected in IT stocks, which have fallen the most over the past month. BSE’s 10-stock IT index has fallen 15.6% since 1 August—the most for any sectoral index—compared with an 8.2% loss in the benchmark Sensex.

The slashing of estimates was reflected in technology stocks, with the IT index falling 1.4% to 4,923.72 in intraday trade on Monday, underperforming the Sensex’s 0.64% fall.

TCS gained 0.6% to 1,027.80 on BSE, Infosys fell 2.23% to 2,263.85, Wipro lost 3.65% to 321.90, HCL fell 3.32% to 384.15, and MindTree fell 0.67% to 343.45.

Citi also examined the correlation between revenue growth of the top four Indian IT services firms and the S&P 500’s operating earnings over the past 48 quarters, which showed a strong correlation with a lag of three quarters. It pointed to the increasing scale of India’s $60 billion (Rs 2.75 trillion) IT industry. The relative immunity it enjoyed as a smaller industry in the slowdown in 2001 wasn’t in evidence during the slowdown in 2008. At the beginning of this century, the industry continued to grow at 20-30%, but after the 2008 global meltdown, revenue growth was flat due to the larger size.

The key risk to the thesis is pricing. Stable pricing is assumed for the next fiscal year at this point, but any further deterioration in the global macroenvironment could put pressure on both pricing and margins, Citi warned.

According to UK-based Ovum, an independent research and analysis firm that looks at technology, telecom and sourcing decision makers, the global IT services market was hit hard in the second quarter (Q2, April-June period) of 2011, with the value of new contracts falling to its lowest level in more than eight years.

Ovum’s analyst Ed Thomas put the total contract value of deals announced in Q2 at just $19 billion worldwide, down 40% year-on-year and the lowest since Q1 of 2003.

The report also found that the number of deals recorded also slumped for the fourth consecutive quarter, to just 384. This is down over 20% on the number tracked during Q2 of 2010, and also the lowest number of deals recorded by Ovum in a single quarter since the last quarter of 2007.

The fall in spending on IT services by enterprises was most noticeable in North America, the most mature outsourcing market in the world. In the first six months of 2011, the region’s private sector total contract value fell to just 15.5% of the global market, against the 39% it held for the first six months of 2010.

In 2007-08, US customers accounted for 60% of the revenue of Indian IT firms. In 2010-11, the number fell to 61.5%.