IT:Optimist on long-term growth despite near-term headwinds

Near-term headwinds persist: The BFSI vertical remains under stress, having witnessed spending cuts in a few segments. Decision making in discretionary spends remains very slow, and there are few indicators of improvement in the same. Negative publicity around visa issues and election year in the US have compounded concerns, driving high local hiring at onsite.

Commentary on long-term prospects reflects a different mood - opportunities abound: Opportunities in the market place remain vast and diverse, allowing companies to pick their preferred areas to drive growth. It may be a few years before high growth in new age services like Cloud, Mobility and Big Data translates into high company-wide growth, given their low current base. In the interim, double digit industry growth would be ensured by traditional services. The industry has thrived on low hanging fruits (BFSI and North America) thus far, focus will shift to underpenetrated segments which still have a lot of growth to offer.

Productivity gains from non-linear models unlikely to exceed ~20%, implying continued demand for talent: The new services' focus also implies high thrust on nonlinearity to de-link revenue growth from employee growth. We understand that the maximum productivity gain to be had through the adoption of non-linear models may not exceed ~20%. While this is a sizeable number we also note that top players like Infosys have already extracted some of the gains. Prospects of continued mid-teen growth for the industry and ceiling on productivity gain imply no softness in demand for quality talent. Currently, India churns out ~700k engineers, of which ~25% are considered employable. This translates to ~175k resources, while the industry is expected to add 200k people in FY13.

Case for pricing cuts strengthening, though management commentaries indicate stability: Low growth environment in the near-term, favorable currency swings, increasing commoditization and clients' stressed financial health all call for possibly negative pricing trends, but management commentary suggests a stable pricing environment thus far. We believe that if the rupee remains weak at INR54-55/USD levels for a period of time, it could trigger more than just sporadic discussions around pricing.

Valuation and view: TCS and HCL Tech will lead growth in FY13, but at 19x FY13E earnings, we see little room at TCS to surpass the street's expectations. Room for upside is higher at Infosys than at TCS, given near-bottom valuations, but we see few near-term triggers for the same. We see better risk-reward for Wipro (on multiple levers to drive efficiency and growth) and HCL Tech (visibility on growth and focus on execution will support multiples).

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