Ambit Cap advises investors to buy HCL Tech & TCS on dips

The IT sector saw 70 percent growth in the previous year owing to weakness in Indian rupee vis-a-vis the US dollar, but recent appreciation of INR may hurt IT companies which are not fundamentally sound, says Ankur Rudra, VP Institutional Equities, Ambit Capital. He advises investors to buy those IT companies which are gaining from US and Europe rebound.  Raising fundamental concerns, he is negative on Tech Mahindra and Infosys while being hesitant on Polaris.In an interview with CNBC-TV18’s Latha Venkatesh and Sonia Shenoy, Rudra anticipates a 10 percent upside for Tata Consultancy Services (TCS) with a target price of Rs 2400 a share thereby recommending investors to buy HCL Technologies and TCS on dips.Stating valuation concerns, Rudra counsels to maintain sell on midcaps; bearish on eClerx Services, Persistent Systems and Mindtree.Below is the verbatim transcript of the interview:Q: Is this going to be a year where there will be portfolio churn and IT stocks may lose a bit of their flavour or do you still buy IT stocks on every dip? What would your assessment be?A: If you look back at the year, the last 12 months, the IT sector has gained about 70 percent overall and of that 70 percent more than half is thanks to currency. So part of it is just pure currency led earnings expansion, part of it was margin expansion and rerating and only a small part of it was rerating thanks to improving business prospects. Our analysis suggests that about 30 percent was actual business performance improving. So 50 percent of this gain was thanks to currency. So given that, we don't think the currency weakness which supported the sector last year will continue this year. If anything it might turn around, our view is that it is much more led by companies which are doing particularly well. So the companies we like for buying on dips are HCL Technologies and TCS. Both these companies are exploiting the recovery in the US phenomenally well, particularly gaining from the opening of the European market. The rebid market in the US is fast growing in areas such as infrastructure management, etc. So those are the two stocks we would recommend investors to buy into dips but the broader IT space we actually turned bearish on over the last few months thanks to the valuation expansion and thanks to the currency led earnings expansion which we don't see benefitting as much going forward. The Second part to the IT story has been the risk aversion that has helped defensives particularly that of IT, pharma and FMCG. If we see the portfolio churn, IT will be one of the parts of the portfolio which will suffer from this as people churn away from and take profits in some of the names they have gained from. If you look at stocks like Tech Mahindra, Infosys, Wipro which is still laggards but did very well.

Q: Are you negative only because these stocks have performed very well and most of the currency move has been priced in or are you negative because there could be some hurdles in terms of the earnings trajectory as well?A: The stocks we are negative on are belong to large and midcaps. The former, we are negative on what we see as fundamental issues. So for stocks such as Infosys and Tech Mahindra, we have got fundamental risks on them. For example, in Infosys, the churn we have seen in senior and junior management has led to some company specific risks in the year ahead. In Tech Mahindra, it is the portfolio we are somewhat concerned about; how long will the growth last in telecom given that their footprint outside of manufacturing is not very strong, how long they can sustain growth and participate in the broader market growth. But the midcap sells are mainly valuations. So the midcap worries we have bearish on share price prospects of the likes of Eclerx, Persistent Systems, MindTree, it is more valuation concerns. Large cap is more company specific. Q: What about Geometric, Polaris? A: We cover Polaris. Polaris will be one of the few midcaps we are concerned about on a fundamental basis. The company has struggled to see improved performance on their services and their software business for the last 12 months. If you see their year-on-year growth in software business is almost next to negligible and they have had a few very serious changes in their business model. They tried to breakaway their services and software business to potentially sell parts of the business which hasn’t really happened. But from our channel checks, it appears that the move has potentially backfired and may be the firm is better selling everything in one go. So, that is another firm where we have fundamental worries not just valuations. In fact, valuations if anything one might say Polaris is more attractive end of valuations in IT. Q: What kind of gains can you get in TCS if you bought it now?A: Our target price for one year for TCS is about Rs 2400. So from here, it is about a 10 percent plus upside. Given how well TCS is doing and the way the market is opening up, there could be some upside risk to our target price. Our target price currently promises about 10 percent but there could be upside risk should the market open up stronger than we currently expect and if there was one company we would bet on in terms of exploiting the market conditions the best, it would be TCS.