On a firm footing

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FY15 is expected to be better than FY14 for IT firms on higher budgets in North America and continued traction in Europe. Sustainable discretionary demand will also help the industry grow faster
On a firm footing
With just three weeks remaining for earnings season to kick off, the weak fourth quarter revenue guidance by two major IT firms TCS and Infosys has kept investors on tenterhooks.

While second largest IT firm Infosys has conveyed that it may only meet the lower end of its dollar revenue guidance of 11.50-12 per cent for FY14, largest IT firm TCS told analysts of a domestic demand-led weakness in fourth quarter revenues, thanks to drop in client spending ahead of the general elections.

TCS is also expecting its profit margin to decline by 40-50 basis points in the March quarter due to re-investment in the business.

Earlier in February, Cognizant had guided 16.5 per cent year-on-year (YoY) revenue growth of $10.30 billion for calendar year 2014, which fell short 17-17.50 per cent growth guidance anticipated by the marketmen.

The recent announcements clearly did not go down well with investors. They dumped IT shares, sending the BSE IT index 9.50 per cent to its lowest this month. Nonetheless, if we go by what analysts say, it is business as usual.

The weak outlook for a traditionally poor quarter for IT sector could not deter the analyst community to recommend ‘buy’ rating on these stocks as they see the worst as being over and FY15 as turning out to be better for the IT sector than FY14, in line with Nasscom’s recent projection. They see higher budgets in North America and continued traction in Europe and sustainable discretionary demand to help the IT sector grow, going forward.

“We reached out to some of Infosys’ peers after the company’s announcement of weakness in demand environment. They aver demand is healthy. Sure, retail and a couple of other verticals in Q4 have been tough because of the extreme weather (winter) in the US but that need only be a Q4 impact – it need not be extrapolated to the rest of CY14, as per peers,” says Viju K George of JP Morgan in a note last week.

Rajesh Gopinathan, chief financial officer at TCS has expressed hopes that the first half of FY15 would be better than the second half of FY15, led by discretionary uptick. However, SD Shibulal, chief executive officer (CEO) of Infosys has bluntly said the recent slowdown may continue to impact client spending in the initial part of FY15. Narayana Murthy, the company’s co-founder, said that the depreciation in rupee from Rs 44 to Rs 62 levels since FY11, failed to be reflected in the firm’s operating margins and that the firm has set an action plan to drive growth and margins.

Here, experts did not fail to point out that Infosys follows the philosophy of “Bad news should take the elevator, good news should take the stairs.”

The firm is conservative while giving guidance. For example, it had initially guided for 6-10 per cent revenue growth for FY14, which was revised to 9-10 per cent, and later re-revised to 11.50-12 per cent in the December quarter’s earnings call. Nonetheless, Infosys is also grappling with exit of senior management personnel, which may hurt sentiments in the near term. Last week, senior vice-president Chandrasekhar Kakal resigned, making him the seventh senior-level exit.

“Kakal’s resignation does not come as a surprise given the recent commentary of further senior-level exits during an investor communication. Still, we believe exodus of senior executives is negative in the near term,” says Sandip Agarwal of Edelweiss Securities.

Nasscom has guided for 13-15 per cent growth in Indian IT-BPM exports for FY15 on hopes of revival in consumer confidence leading to return of discretionary spending and increased demand from US and Europe. This was the highest guidance in the past three years.

Ashwin Mehta of Nomura India believes that no weakness across verticals and better discretionary outlook for FY15 by TCS reinforces the brokerage’s confidence that the demand trends in the sector remain intact. The expert believes a slower-than-anticipated discretionary pickup, rupee appreciation, and the US immigration bill pose downside risks.

“HCL Technologies, TCS and Tech Mahindra followed by Infosys remain our pecking order of preference within the sector, within our buy recommendations,” Mehta says.

On Wipro, HDFC Securities pointed out that the weak start in the first quarter has been taking a toll of Wipro growth in the past three years.

“We believe that Wipro’s turnaround would face a litmus test in Q1 FY15E. Street would eagerly wait for Q1 FY15E revenue guidance to gauge the sustainability of Wipro’s turnaround,” the brokerage said in a note. Wipro has given $1,712-1,745 million revenue guidance for the fourth quarter.

Among the midpcap and smallcap IT stocks, experts advised investors to be selective. Ravi Shenoy, AVP for midcaps at Motilal Oswal Financial services believes that investors should closely follow the first quarter/FY15 guidance, number of deals win in the March quarter and rupee movement to gauge stability in the IT sector.

“If we look at the recent correction in the IT stocks, it was all due to rupee depreciation and lowering of guidance by two major IT firms. But, we see demand improving in FY15 in line with 15 per cent growth expected by Nasscom. Among the tier II IT stocks, we like Persistent Systems and MindTree. Persistent Systems has a unique business model that helps it achieve high operating margins. We see the firm report at least 25 per cent revenue CAGR over the next two years,” Shenoy says.

Sudip Bandyopadhyay, CEO and MD at Destimoney Securities, is bullish on TCS and HCL Technologies among the large caps, while he sees Tech Mahindra and Hexaware Technologies performing well in the midcap space looking at their recent strong quarterly performances. The market expert is cautious on KPIT Cummins.

Stock performance

Indian Infotech, MindTree, HCL Technologies and Hexaware Technologies have plunged 23.16 per cent, 15.45 per cent, 9.49 per cent and 6.65 per cent, respectively.

“In the near term, investors' preference for high beta stocks and a potential appreciation in the rupee against the dollar (though the currency is not expected to go below Rs 60) could restrict any meaningful outperformance by the IT stocks,” says brokerage Sharekhan in a note.


This article taken from http://www.mydigitalfc.com/it/firm-footing-049