See persistent period of lower IT growth: Equirus Sec

Bhavin Shah of Equirus Securities says he continues to remain bearish on the IT space. Equirus has been cautious on the Indian IT sector since August of last fiscal. He believes that the sustained period of lower growth for IT service industry will continue going forward.

Uncertainty about spending by US and European clients in a weak global economy is weighing on the earnings of Indian outsourcers, dampening hopes that demand will pick up in the second half of the year.
Shah also is of the view that IT’s traditional businesses are getting commoditized. "Now with lower overall growth opportunity more companies are competing for the same pie so pricing is a normal thing that will happen," he says. Below is an edited transcript of his interview to CNBC-TV18. Q: Do you share the skepticism that a lot of people have on the sector right now, despite TCS’ numbers, the fact that demand conditions might worsen some more as the year progresses?
A: We have been cautious on the sector since last August for number of factors and some of those factors are now beginning to play out and TCS has done relatively better - thanks to some of the earlier initiatives on platform BPOs as well as product solutions. Overall TCS’ growth rate has also fallen significantly on US dollar terms from a year ago. So we believe that we are seeing a sustained period of lower growth for IT service industry going forward.
_PAGEBREAK_ Q: The other thing that may come to back and bite them is the pricing issue - something we haven’t seen at least till this quarter. You think its going to be a one-two punch where volume is not moving and pricing begins to slip as well?
A: IT companies are generally accepting the fact that their traditional businesses are getting commoditized and differentiation is harder to achieve. Now with lower overall growth opportunity more companies are competing for the same pie so pricing is a normal thing that will happen. Customers understand the rupee benefits though they are also pressed for it. We saw early signs of that in the June quarter numbers and we will see a lot more of it in the coming quarters. Q: You have tracked this space for many years. What is going so wrong with Infosys?
A: First of all there is an overall growth issue facing the industry and no company can be immune from that and no company is immune from that. We believe Infosys haven’t done any significant acquisitions. One of the factors that I see the growth differential between TCS and Infosys is that TCS is doing well with their Platform BPO. The acquisition that they did of Citi BPO helped them in that respect. That is one element that I think is missing.
Infosys is traditionally a conservative company in terms of taking certain risks associated with revenues. For e.g. infrastructure management services - they seem to avoid certain opportunities there because they feel there is a balance sheet risk involved in doing those projects. So no wonder why they have the industries leading core return on capital. They are basically focusing on quality and trading quality for quantity in terms of growth rates. That’s another factor that’s affecting Infosys. Q: It does stand at cross purposes though what TCS is saying right now about the environment or at least their body language, if you had to stack these stocks in terms of who you think will weather the storm best? Who do you think will come out tops?
A: When you say weather the storm, it depends on what you mean. TCS continues to have better momentum for growth and I think that doesn’t seem to be changing anytime soon, at least not for September quarter. However, TCS’ management has mentioned to analysts in June that they expect the growth to be front-end loaded otherwise they also expect some slowing of growth in the second half.
In recent commentary they have also essentially lowered their growth outlook by mentioning that the Nasscom growth numbers need to be adjusted for cross currency mix. So yes, TCS will have a stronger growth compared to Infosys but that absolute number is coming down.
With regards to valuation for that kind of growth, TCS’ valuation has more risk of a correction than Infosys at this point. For other companies like HCL Technologies, because of its more aggressive stress on pricing, it could continue to report stronger growth numbers. Wipro on the other hand could also struggle to deliver growth. Q: Do you agree with the observation which other IT analysts made which is that midcap IT seems to be faring this down-wave better than the last time round or do you think it is only a matter of time before we see cracks in IT’s performance and we know that those stocks can suffer a lot more?
A: There are number of factors; midcap IT companies went through a rough period. Different companies have a different story to tell but broadly speaking they consolidate their offerings around areas of strength. Some of the niche areas where midcap companies have advantages are really taking advantage of that.
Secondly, the deal size is smaller which suits the midcap companies a bit more. Third is the pricing. Generally speaking, midcap companies have lower pricing. When commoditization is happening pricing does play a role in getting business. Fourthly, I believe that consultants play an important role. Consultants guide customers on who to use for IT services. I believe they are playing an increasingly important role.
For example, helping a lesser known customer somewhere in the middle of USA to link with a lesser known IT company somewhere in middle of India. That linkage is happening through the consultants and that is also helping midcap IT companies.
Now if overall growth rates continue to be weak, then midcap companies will also see their growths coming off but the valuations generally are not demanding in midcaps. So I don’t expect any need for a major correction there.