Growth indicators signal near term pressure in IT space

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Growth indicators signal near term pressure in IT space

PINC Research has come out with its report on IT space. The research firm remains neutral on the sector with a positive bias for Infosys based on the current market price.

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PINC Research has come out with its report on IT space. The research firm remains neutral on the sector with a positive bias for Infosys based on the current market price.

Growth indicators signal near term pressure: Cognizant has given 23%YoY revenue growth guidance for CY12. NASSCOM has forecasted 11-14% growth for IT-ITeS export revenues in FY13. Our revenue growth expectations for Tier-1 firms are in the range of 12-16%. We remain neutral on the sector with Infosys as our preferred pick.

• Healthy revenue growth, stable operating margins: Cognizant revenues for Q4CY11 grew 3.9%QoQ to USD1,663.7mn, thus outperforming the guidance of 3.7%QoQ growth. CY11 revenues had 33.3%YoY growth at USD6,121.2mn in line with the company's guidance. Operating margins for Q4CY11 improved marginally by 22bpsQoQ to 18.52%. Whereas for CY11 operating margins had marginal decline of 20bpsYoY to 18.57%. Diluted EPS for Q4CY11 and CY2011 were USD0.78 and USD2.85 respectively.
• Revenue contributions from clients in North America, Europe and RoW during Q4 were 79.8%, 16.5% and 3.7% respectively. While North America grew 6.1%QoQ, Europe declined 5.6%QoQ due to negative
  impact of cross currency movements. In constant currency basis, Europe declined 2.7%QoQ. Application development (51% contribution) and Application management (49% contribution) grew 4.3%QoQ and 3.5%QoQ respectively.
• During Q4, Financial Services (40.9% contribution) grew 3.7%QoQ, Healthcare (27.5% contribution) grew 6.3%QoQ, Retail, Manufacturing & Logistics (19.2% contribution) grew 2.8%QoQ and other industries
  compromising Communication, Media & Entertainment (12.5% contribution) grew 1.3%QoQ. Cognizant added 317 new clients and increased the number of strategic clients by 25 to 191.
• Strong CY12 revenue growth guidance: Cognizant has guided for 23%YoY revenue growth in CY12 at USD7.53bn. For Q1CY12, the revenue growth guidance is at USD1.7bn (2.2%QoQ growth) Diluted EPS
  guidance for Q1CY12 and CY12 are at USD0.79 and USD3.43 respectively.

NASSCOM's forecast for FY13: For FY2011-12, overall Indian IT-BPO industry is expected to surpass USD101bn. This includes USD69 in export revenues (excluding hardware) indicating a growth of 16.3%YoY during FY12. For FY2012-13, NASSCOM expects the exports revenues to grow by 11-14% whereas domestic revenues to have a higher growth rate at 13-16%. The slowdown is expected due to delays in decision making witnessed by leading IT services players in an uncertain macroeconomic environment. NASSCOM would be reviewing its forecasts during the mid of fiscal when it expects the various companies to have a better visibility about client budgets and spending patterns.

Cognizant expects a weaker quarter in Q1CY12 and a good pick up in Q2 (revenue growth of around 7%QoQ) when the budgets are frozen and spending is increased. Then Q3 is also expected to be equally good with high growth of ~7%. The pattern appears to be similar to 2011 when Q1 grew 4.7%QoQ followed by 8.3%QoQ and 7.8%QoQ growth in Q2CY11 and Q3CY11 respectively.

Cognizant has been able to grow at much higher pace than the competitors in India like Infosys, TCS and Wipro due to its aggressive approach to win clients. Our expectation of 13%, 16%, 13% and 12% dollar revenue growth for Infosys, TCS, Wipro and HCL Tech is broadly in range of NASSCOM's guided range of growth in FY13. Since, historically tier-1 Indian firms have outperformed the NASSCOM's initial guidance; there might be a possibility of delta upgrade in our volume growth assumption for tier-1 firms. Nonetheless, stocks have outperformed over the last one month. We currently have 'ACCUMULATE' rating on Infosys, TCS and HCL Tech and REDUCE rating on Wipro. A potential upgrade towards BU Y might happen only in a scenario when outlook in US and Europe starts to improve. Although we have some early signs of improvement in US where unemployment has started to decline and economic data reflects improvement but outlook regarding tech spending is still cautious in US.

We remain neutral on the sector with a positive bias for Infosys based on the current market price.

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