With a fortnight to go for the fourth quarter earnings announcements, tech companies have already indicated that they may face headwinds due to cross currency moves, the latest being HCL Tech. So now the big question is whether the sector headed for a deeper consolidation?
Shashi Bhusan, IT analyst at Prabhudas Lilladher says constant currency growth in Q4FY15 will be better year-on-year. He says the dollar strength will impact profitability by 30-60 basis points for IT companies.
Below is the verbatim transcript of Shashi Bhusan's interview with CNBC-TV18's Menaka Doshi and Anuj Singhal.
Menaka: Take a look at any of these companies – HCL Tech, TCS, Mindtree, Wipro, NIIT, they have all guided close to 200 basis points hit on dollar revenue on account of cross currency issues and close to around 50 basis point hit on margins. How concerned are you on what this will mean for profitability of IT business?
A: Most of the companies have got similar composition coming from different currencies whether it is the US dollar, euro, GBP and JPY. Since the composition of revenue is very similar that is why the impact of revenue because of USD appreciation is somewhere similar between 200-250 basis point, in some cases it is little bit stretched to 280 basis points as well. There will be some impact on profitability or operating margins as well because rupee has strengthened against the euro and GBP over the last quarter. So, profitability will actually get impacted by 30-60 basis points for different companies. However, try to understand, when you value a company or when you look at a company from a longer-term perspective, you evaluate the demand environment more than these quarterly aberrations.
The demand environment is not getting worse, if you look in constant currency terms on a quarter-on-quarter basis growth, Q4 FY15 growth will be better than Q4 FY14 growth and that is a very heartening to see. So, the demand environment is only getting better and we are not seeing any worsening of that – there could be one or two cases of aberrations which happened in case of Mindtree, KPIT and Persistent, but otherwise structurally we still see a good demand environment for the industry.
Menaka: On the issue of demand environment again companies have been talking down expectations, TCS has done that already in its mid quarter review with analysts. It is not to say that the last quarter – these are all big companies doing very well so I am not casting a shadow on their performance but I am saying the outperformance that the street had come to expect from some of these leaders in the IT business now seems to get moderated or being getting moderated over time. Would you say that while this quarter, the last quarter of FY15 will be better than the same quarter last year? The momentum has slowed a little bit.
A: If you look at constant currency growth, it is almost same or may be marginally better. Even TCS commentary was that it is going to be at least as good as previous year this quarter constant currency growth. Obviously, last year in this quarter you did not have cross currency headwinds which you have this quarter and that is what is affecting your revenue growth in US dollar terms. Obviously, it is impacting your margin also because despite revenue contribution it is 20-35 percent. The currency appreciation is so stark that it is bound to have an impact on operating margins.
Otherwise in terms of demand environment there could be one or two clients deferring their projects or the project ramp up got pushed to the next quarter, that is impacting revenue, otherwise structurally I don’t see any significant difference than what we were seeing in the last few quarters in terms of demand environment.
If you look at the numbers that came from some of the larger players also, even Accenture reported the number, software company like Oracle reported – all of them reported very healthy numbers. That clearly indicates that things are not worsening from where we were say 3-6 months back.
Anuj: We have seen most of the IT stocks barring Infosys and Wipro actually correct in double digit percentage terms, TCS has corrected some 11 percent and Tech Mahindra good 16 percent, what is your pecking order in terms of stocks which you believe could outperform from here?
A: Quarterly movement of stock price is difficult to predict but our pecking order still holds - this has not changed over the last one or one and half years. It is Infosys, followed by TCS and Tech Mahindra in large caps.
In midcaps, we continue to like KPIT, Hexaware, Persistent and Mindtree. So, these 7 stocks continue to feature in our favourites.
Anuj: For TCS in particular for last two analyst meet the body language hasn’t been as aggressive or as bullish as it has been in the past and the stock market has taken a note of that. Would you say that these concerns are minor and is this still a good buy or would you change your estimates a bit on TCS?
A: Quarterly things are a little more different but when you look at a company for two or three years horizon, things are very different. In case of TCS yes, there are a few things that are ailing them. I would say quarterly fluctuation in telecom vertical. Some structural weakness in insurance right from their BPO side and even in non-BPO in IT services side they had some problem. These two concerns actually affected their revenue momentum over the last two quarters but when you are running a massive ship like USD 14-16 billion kind of quarterly run rate these one or two quarters of weakness should not bother investors. They have done great and I still feel the leadership team is in place that can drive the momentum wherein they will extract at least at the upper end of NASCOM guidance even in FY16.
Menaka: I am glad you brought up Accenture in a previous response because Accenture raised its FY16 growth guidance to 8-10 percent from the earlier 5-8 percent. it said new order booking was up over 20 percent quarter-on-quarter. Now that is a very different aggressive growth language then companies like TCS or even Tech Mahindra have been speaking in this marketplace and today HCL Tech got added to that list. Are Indian companies moderating expectations so that they can outperform what the street puts down as estimates? Is Accenture telling us an outlier story simply because it is among the top two or three companies and that same kind of growth will not trickle down to Indian companies? Can you explain or reconcile how come Accenture has had such a great quarter but Indian companies sound a lot more muted?
A: If you look at growth rate of Accenture in constant currency terms, guided for some 10 percent upper end where even one of the worst or few of the worst performers would be doing better than that. So Indian IT companies are not losing market share when you put things in context. Now so far moderating the expectation or managing the expectations are concerned they talk about the environment they see at that particular point of time. So, there could be one or two quarters of weakness and that weakness might be very client specific or geography specific and stuff like that.
I don’t think that they are trying to hammer down our expectations and then try to outperform. That is not the scenario which we are looking at. They actually saw some headwind and they highlighted about that and my sense is that once things will start looking better they will guide about the same.
Another thing you should keep note of is that Indian IT companies don’t disclose order book. So sometime it becomes little difficult to evaluate these companies that how they are going to perform, say next quarter or quarter subsequent to that. So we have to look on the qualitative assessment of management commentary which comes out and we don’t have any other option. So sometimes the interpretation could be vaguely different from one analyst to another.
Menaka: These cross currency headwinds and these temporary pressures as you put it, all they all baked into the stock prices at this point in time or do you think that there is scope for disappointment as earnings start coming in?
A: There could be some minor disappointment even when the earnings start coming or there will be some readjustment to the number, but if you ask me what I would be recommending to my client I would be recommending my clients to buy into those weakness and stay unfazed with these quarterly aggressions.
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