Investors should focus on biggies like TCS, Infosys

There is no respite for the IT sector amidst the current market turmoil. The sector was looking forward to the September quarter results, expecting a
bounce-back in its valuations, since historically, IT companies post good performance in the second quarter.

However, despite better-than-expected Q2 results, IT companies are witnessing a sharp fall in valuations. During the current market crash, all the top five IT companies have witnessed a sharp fall in their priceearnings (P/E) multiples. The P/Es of Tata Consultancy Services (TCS), Wipro and Satyam Computer Services have halved from their levels at the beginning of the current calendar year. Global macroeconomic turmoil and uncertainty about future demand scenario are the major reasons for the decline in IT scrips.

During the current quarterly results season, all the top seven players, along with some small and medium-sized companies, have declared results so far. While the Q2 numbers are impressive in rupee terms, the dollar-term guidance given by some of the companies is a cause for concern. Most companies that have stated guidance for the December ’08 quarter have factored in a sluggish trend going ahead.

Companies, including Infosys Technologies and Wipro, expect to see barely any growth in their toplines on a sequential basis, while Satyam expects a much muted growth compared to earlier quarters. What is worse is that it expects a sharp fall in earnings per share (EPS) in the December quarter. Patni Computers has also indicated a drop in sales and net profit, going ahead.

The concern is not limited to the December ’08 quarter. Companies including Infosys and Satyam have cut their forecasts for FY09 as well. These tier-I companies now expect growth in lower single digits for the whole year. In the near term, this spells a rather gloomy scene for the sector, which had seen high double-digit growth so far.

It needs to be noted that the uncertainty about future growth has overshadowed the resilient performance shown by some of the big and small IT players during Q2 ’08. Boosted by a depreciating rupee against the dollar, the top five IT companies recorded a 9.3% sequential growth in revenue, while net profit (PAT) grew by 10.2%. This reflects a marginal expansion of 20 basis points (bps) in net margin at 19.2%. Reckoned year-on-year, sales at the aggregate level rose by 32.4% — much faster than the PAT growth of 18.6%. This means that net margin contracted by 220 bps y-o-y.

Currency fluctuations resurfaced as a potential dampener during Q2 ’08. The rupee depreciated by more than 8% during the quarter compared to the previous quarter. Further, depreciation of the euro and British pound (GBP) against the dollar also impacted the performance of Indian IT companies, which earn more than 80% of their revenues in these three currencies. Among top companies, TCS reported a currency loss of over Rs 261 crore. Wipro reported a forex loss of Rs 28 crore.

Discussions with industry analysts reveal that going ahead, some IT companies, including HCL Technologies, have decided not to take fresh forex hedges, while others such as Infosys have taken a short-term view on hedging. Satyam, on the other hand, has reduced its hedging exposure by half, compared to the figure at the beginning of the current fiscal.

Though the forecast given by IT players is sombre, one ray of hope is that most companies have reiterated they will continue with their hiring plans. Further, the deal pipeline appears healthy, notwithstanding the current global crisis.

Though the future performance of IT scrips depends upon how overall market sentiments shape up, investors are advised to remain focused on biggies, including TCS and Infosys, which have the size and scale to weather the storm. Among mid-sized companies, Mastek looks attractive. The company has shown a stable performance during Q2. Its acquisition last year and its strong hold on the insurance space are expected to keep the company on the growth path.

Source: EconomicTimes