BP Equities positive on Mahindra Satyam, Tech Mahindra

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BP Equities positive on Mahindra Satyam, Tech Mahindra

BP Equities has come out with its Q3 FY12 IT services earnings preview. The research firm has maintained buy rating for Infosys, HCL Technologies, Mahindra Satyam and Tech Mahindra whereas maintained hold rating on Tata Consultancy Services (TCS) and Wipro.

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BP Equities has come out with its Q3 FY12 IT services earnings preview. The research firm has maintained buy rating for Infosys , HCL Technologies , Mahindra Satyam and Tech Mahindra whereas maintained hold rating on Tata Consultancy Services (TCS) and Wipro .

Significant Rupee depreciation to boost top line and expand margins while cross currency aberrations and less working days to impact dollar revenue growth We expect December quarter performance to be a weak one, specifically on the volumes growth and dollar revenue growth front primarily due to lesser working days (on account of holidays), shut down at certain client's site (in manufacturing vertical) and dollar appreciation against euro and pound. We expect volumes growth for Top four IT companies to be in the range of 3-4% in Q3 FY12. Moreover, adverse cross currency movement, with USD gaining 4.9% against Euro, 2.4% against GBP and 3.6% against Australian dollar (all quarterly averages) will have an adverse impact of around 150-200 bps on dollar revenues growth and will put pressure on billing rates. Taking all these factors into account we expect dollar revenue growth to be in the range of 2-4% for the quarter. However, sharp rupee depreciation of 11% against the dollar will boost top line, which we expect to come in the range of 11-14% Q-o-Q. We expect Infosys to meet mid range of its guidance (US$ 1,802-1,840 mn up 3.2-5.4% Q-o-Q) while Wipro to report a little higher than lower end of its USD guidance of US$ 1500-1530 mn up 1.9-3.9% Q-o-Q.

Weaker rupee to boost margins for all IT exporters
We expect all IT companies under our coverage to report expansion in margins due to significant rupee depreciation against dollar and absence of wage hikes (except for Mahindra Satyam) for the quarter. Generally 1% depreciation in rupee results in margins expansion of 30-40 bps. Thus, we expect margins expansion in tune of 100-300 bps for all IT companies offset by adverse cross currency movement and reinvestment in business. We expect TCS and Infosys margins to expand 288 bps and 268 bps Qo- Q to 32.0% and 33.7% respectively in Q3 FY12. Wipro Ltd recognizes forex losses in its top line which results in lower rupee realization and thus will not benefit much on margins front. We expect Wipro margins to expand 128 bps Q-o-Q to 20.6% in Q3 FY12. HCL Tech management said that it will reinvest its gain from rupee depreciation into business and thus we expect margins to expand only 146 bps Q-o-Q to 18.5% in the quarter.

Lower forex hedges to benefit Infosys and HCL Tech
INR has depreciated significantly (~11% in the quarter) and companies with lower hedges are going to benefit the most due to lower forex losses. HCL Tech has total hedges of US$713 mn in forward and Options booked b/w Rs 48.3/$ - Rs 49.7/$ (~70% of Q2 FY12 revenues) and Infosys has US$ 743 mn of forward hedges (~40% of Q2 FY12 revenues). Wipro has total hedges of US$ 1.6 bn (~110% of Sep11 revenues) and TCS had forward contracts and options of US$ 2.8 bn (~111% of Q2 FY12 revenues). We believe Infosys and HCL tech, which has lowest forex exposure are set to benefit the most from rupee depreciation while Wipro (which realizes forex gain/loss on the top line) and TCS will face the heat going forward.

Valuation & Outlook
Global uncertainties, weaker economy and ongoing sovereign debt crisis in Europe has decreased the prospects of technology spending in FY13, as a result Gartner too has cut the IT spending forecast for CY12 to 3.7% from 4.6% earlier. However, we don't see any significant budgets cuts in RTB (run the business) deals however discretionary spending (transform the business spending) will face some delays and cuts. We expect Tier-1 IT companies to post double digit dollar revenue growth for FY13E. Rupee depreciation will boost revenues in dollar terms and help expand margins, as we don't see significant salary hikes lined up for FY13 and attrition will be under check. Pricing will remain more or less stable. We have assumed US$/INR rate of ~48 for FY12E and ~50 for FY13E. We maintain our BUY rating for Infosys, HCL Tech, Mahindra Satyam and Tech Mahindra whereas maintain our HOLD rating on TCS and Wipro.

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