Indian IT stocks have had a very good start to 2018 with the Nifty IT index up nearly 10 percent at a time when general indices are not doing too well. So far stocks like Tata Consultancy Services (TCS) and Infosys have gained in-line with the index. Have the stocks bottomed out and more importantly, has the business bottomed out?
In an interview to CNBC-TV18, Moshe Katri, MD at Wedbush Securities spoke about the IT stocks and the way forward for the sector.
In our universe, we like Accenture, we like Cognizant, we like WNS among the three pure play BPO names. Let us put it this way, this is a good year for probably the entire space, he said.
Below is the verbatim transcript of the interview:
Latha: Is Indian IT out of the woods. Can you see them taking over that digital challenge?
A: We are out of the woods, so far so good for 2018. My biggest concern is that we started in a very specific similar way of 2017 and then sometime in May-June of last year things went on to south, so we have to keep on tracking some of the trends. At this point of time the spending trends are looking better. The industry went through a very massive disruption during the past three years. The models moved from more to less capital labour intensive models; a lot of did move to the cloud, a lot of them moved to software and service model, companies using automation, all this is introducing cannibalization and it almost have to be in a catchup mode to all these trends, if you are not setup for that - that is really challenging. The good news about this year as I said spending trends are looking better and even on some of the legacy stuff, companies are spending more. Digital initiatives are moving from millions of dollars of initiatives to billions of dollars of initiative specially if you are looking at some of the banks. So if you have the right skill base you should be in a decent shape
Business Process Outsourcing (BPO) looks very good. BPO has been healthy for couple of years now, we cover three of the pure plays WNS, EXL and Genpact. There the demand looks very healthy, it's a bit different than IT services and these companies kind of reinvented themselves because they are doing a lot of work in analytics on top of the traditional business. So, so far so good, the tone looks good and as I said the trend looks good and the only thing that can make things go south is the politicians but we will see what happens.
Anuj: You said even for legacy order things are beginning to look good but this point on digital and the fact that orders are turning large and we have seen that play out in midcap IT in India particular where you do not have legacy issues. Do you think that still remains the better way to play compared to the likes of Infosys and TCS?
A: It all depends. Let's look first at the digital mix of the tier ones. I would say probably the leader among the group is Accenture. For Accenture we call about 55 percent of revenues and below that is Cognizant at about 30 percent and if you look at TCS and Infosys, they are probably around 20s and if you look at Wipro, it's probably lagging a bit behind. If you look at some of the midcaps you also have to look at the mix. We cover a couple of pure play digital companies - EPAM, Luxoft, Globant these are companies that generate 100 percent of the revenue base from digital and these are companies that are going 25-30 percent a year because this is the sweet spot right now and there are companies that are getting there. We cover company called Virtusa. Virtusa has done well, they have had a difficult time after acquiring Polaris a year-year-and-a-half ago and now it seems it's kind of beginning to pay off. One thing that I haven't mentioned is that the largest vertical on the sector is banks, financial services & insurance (BFSI) and that is the wildcard. BFSI had a good start last year, it didn't end well. BFSI is having a good start this year, so far it is looking better but I always tell clients budgets are not ingrained in stone. If my early budget says that I am going to be up 3 percent, it doesn't necessarily mean that that is going to happen; things change very quickly in the sector.
Sonia: In fact I also wanted to ask you about the largecap companies. We recently spoke to the management of TCS and they indicated that the deal pipeline has picked up a lot over the last two-three months. They were talking about USD 6 billion of deals just in the last three months.
A: We heard the same thing.
Sonia: But the stock has gone up about 15 percent this year. You think the good news is already in the price?
A: I would say a couple of things on this. One, most of the investors that we talk to are still staying clear and away from the sector. So we definitely will see the incremental buyer, if we will continue to see some of the trends that we thought were going to happen earlier this year - that is a good thing. Second, if we are going to see better growth rates for some of the largecap names, I think the multiples will continue to rerate because it is really difficult to find largecap tech companies that are growing north of 10 percent a year. Again, we are going to see deviation probably this year for what we have seen in the past two-three years which is reacceleration of growth, a lot of the bears that always focus on margins will probably be disappointed because the margin outlook looks okay, doesn't look bad and if you are worried about H1B visas even that looks better despite all the noise that is out there and continue to be out there.
Latha: Will you expand your focus in India to more midcaps?
A: We cover a bunch of names that trade in the US. We cover Cognizant which could be considered the midcap but 30 percent of the revenue base is digital roughly 55 percent of revenues is BFSI, 30 percent is healthcare, these are verticals that are doing better.
Anuj: In terms of multiples, TCS for example there was a time when it crunched to 15-16 times, it is almost back to trading at 20 times thereabouts. Infosys went to about 13, its back to about 16-17 times. How much more do you think is there a room because right now it is only a promise, we haven't said that turn into numbers.
A: Couple of things - if we are going to see growth north of 10 percent this year, I can guarantee that next year's numbers are not showing you 10 percent growth yet. So numbers will go higher. Therefore, the multiple will continue to rerate and that is my view. So at this point of time it's too early.
Sonia: There is a lot of scope for growth and for transformation in this sector. Which company do you think is the best place to leverage on that?
A: In our universe we like Accenture, we like Cognizant, we like WNS among the three pure play BPO names and we have some of the other.
Let's put it this way, this is a good year for probably the entire space and I am saying it for a couple of reasons. One, because we are seeing better spending on the legacy side, it will provide enough time for some of the other companies to ramp up their digital strategy. So it is a good time for that transformation to happen because you are almost getting extra time to do what you need to do without the crunch time that you had in the past few years.
Latha: In your list you didn't mention any of the Indian companies. Are you happy with the way they are dealing with their workforce, after all it has to be either retrained or fired and rehired? Is that satisfactory?
A: I think it is and when Accenture started digital transformation that was five years ago. Most of the India based firms probably started a couple of years ago. It is not a transformation that happens on a day especially when you are carrying two-three hundred thousand people on your bench, it is going to be a work in progress - that is how you have to look at it. Everybody is doing something about this but it doesn't happen in a day and it is going to be a long transformation unless you see some large merger and acquisition (M&A) transactions which is highly unlikely.
Anuj: Some of the new technologies, Blockchain for example or artificial intelligence (AI). Are there any Indian companies which are doing work here?
A: The three BPO companies that I mentioned are doing a lot of work in artificial intelligence robotics - that is how they have been able to transform their business model. I mentioned WNS, they will probably grow 13-15 percent this year; pretty impressive for any company in the space.
On the Blockchain side you are definitely seeing some work that is getting done. IBM advertises it across the board, Accenture does some work especially on the Blockchain technologies that are related to enterprises, B2B but at this point I do not think that is going to move the needle for the industry.
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