Buy HCL Tech, Infosys: Prabhudas Lilladher

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Buy HCL Tech, Infosys: Prabhudas Lilladher

Prabhudas Lilladher has come out with its report on IT space. The research firm recommends buy rating on HCL Tech and Infosys.

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Prabhudas Lilladher has come out with its report on IT space. The research firm recommends buy rating on HCL Tech and Infosys .

After a see-saw performance in H1FY12 against expectation, Q3FY12 performance of Tier-1 Indian IT Services (TCS, Infosys, Wipro, HCLT) have been in-line with expectation. However, softer-than-expected volume growth has been compensated by efficiency drive in fixed-price projects. The new clients win has been healthy, but top clients have been a drag for Tier-1. Moreover, global tech majors' results indicate moderation, corroborated by TPI index report. We expect Tier-1 to deliver 15%+USD revenue growth. We reiterate 'BUY' on HCLT and Infosys and 'Accumulate' on TCS and Wipro due to limited upside.

In-line performance driven by efficiency gain: Top-4 delivered Q3FY12 in-line with expectation driven by lower volume growth, but stronger pricing (led by efficiency). Infosys delivered the strongest growth of 3.4% QoQ (Volume:3%; Pricing:-0.1%; @CC:4.4%), TCS of 2.4% QoQ (V:3.2%; P:2% C:4.5%), Wipro of 2.2% QoQ (V:1.8% P:2.5% C:4.5%), and HCLT of 2% QoQ (V:4.9% P:-1% C:3.7%). Q3FY12 was the slowest quarter (2.6% QoQ) since Q1FY10 in USD terms. Top-4 added only US$173m of incremental revenue, weakest since Q2FY10. However, we believe that performance has troughed and expect strong client addition to contribute improved volume growth in FY13 (mid single-digit QoQ growth).

What surprised us? Positively 1) Currency depreciation and operational efficiency pushed margin expansion by 175bps QoQ (strongest ever) 2) Rupee revenue growth was 12.7% QoQ, whereas USD revenue growth was 2.6% QoQ 3) Blended pricing grew by 1.1% QoQ driven by FPP efficiency 4) 70 net new clients added by Tier-1, strongest in the last 16 quarters 5) Lateral hiring were at same level as the last quarter 6) Total employee grew by 4% QoQ, in-line with volume growth 7) Onsite revenue contribution grew by 18bps, 9th consecutive quarter of uptick (excluding OND-10) Negatively 1) Volume growth at 3.1% QoQ 2) Commentary on deal pipeline continues to be cautious 3) Top-10 clients grew by 0.9% QoQ, 5th consecutive quarter of slower than overall growth 4) Revenue productivity (Revenue/Billed man-months) declined by -0.5% QoQ.

What to expect? 1) We expect deal pipeline to improve 2) We expect EBITDA margin to retreat towards mean (~150-250bp erosion) 3) We see attrition and cost pressure easing out further.

Global tech majors' result indicates moderating demand: Global technology majors have reported quarterly results in-line or touch below expectation, reaffirming moderating demand environment.

Remain positive on Tier-1: We reiterate our neutral stance on Indian IT Sector. We expect volume growth to be in mid-teens range. We reiterate our 'BUY' on HCLT and Infosys and 'Accumulate' on TCS and Wipro, with a target price of Rs530, Rs3,080, Rs1,230 and Rs460, respectively.

Public holding more than 90% in Indian cos

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