Despite macro concerns, IT still poised for 8-10% growth: JPM

All IT companies in India are facing macro concerns but the sector as whole can grow at 8-10 percent sustainedly, says Viju George, IT Analyst at JP Morgan.

There is some value in select IT stocks and huge value in companies like Infosys and Tech Mahindra, George told CNBC-TV18 from the sidelines of JP Morgan India Investor Summit.

He further said that there is no reason for growth in the IT sector to slow down to 4-5 percent.Below is the verbatim transcript of Viju George’s interview to Anuj Singhal, Latha Venkatesh & Sonia Shenoy on CNBC-TV18.Latha: You are the most important person in the entire pantheon of JP Morgan guest simply because it is eerie that IT is underperforming. What is your sense basically about earnings itself? Is it that we have to get adjusted to a 20 percent growth sector becoming a 10 percent growth sector or is it much more calamitous?A: There are people who are sounding the death knell for the sector. I think they have been overly pessimistic. The reality is that there are companies still growing at almost double digit growth. Can you point too many double digit growth sectors in Indian economy? There are surely. There are concerns that do emerge from time to time and together those are confluence of those concerns such as are we positioned to capture the opportunity? Is the core commoditising? How is the fragmentation? Are the MNCs like Accenture running away with the game etc? So, those worries have taken toll on the stocks. Lately, we have seen a weakness on the macro front from financial services. So, all of that has meant that stocks are very attractively priced today.When was the last time that Infosys was at a 20 percent discount with a Nifty? Probably, only after the Lehman Brothers crisis in April or February 2009, we are not approaching that stage yet, so my sense is that the stock has sort of factored some of the events and I don't certainly foresee a calamity. So to my mind there is value in certain stocks.I can’t say for sure that Q2 will be a good quarter that is the current quarter. However, I think for the investor who is willing to look beyond the near-term there is value in some of these names.Latha: How you have distilled all the calls that have come from Infosys and from the Tata Consultancy Services (TCS) speaking to analyst? What is that in terms of earnings growth and what is it in terms of the longer game for IT companies? Are they out of the game in the global competition? Have they surrendered it to Accenture? Give me a near-term and a longer term view?A: The near-term, there are macro concerns and I don’t think necessarily that it is appropriate to say that Indian IT companies will be losing out. My sense is that even if you take a well managed company like Cognizant for so long managing the growth premium in the sector, they have also pointed out to slow down. So, this is a macro impact right now which is present for all companies. So, there is no evidence to suggest that Indian IT firms are specifically losing market share.That said, the base affect is there; there is also some part of the business that is commoditising so you are not going to get growth rate to the future. My sense is that industry is still poised for what I would say is 8-10 percent growth on the sustainable basis. Do I see it nose-diving to four or five? The answer is no. In that context, I would probably look at those managements which you think can manage 8-10 percent or plus on a sustainable basis.If the rupee does not depreciate further? My sense is that if you take the earnings growth will lag behind topline growth and that is something we should build in our models. However, if you see 2-3 percent depreciation on the rupee every year, which shouldn’t be a difficult situation right now particularly if the US raises interest rates, I do believe that we should be able to hold on to margins provided the global macro looks up and does the revenue growth. I still think 8-10 percent earnings growth is possible for the industry.Latha: Where does value lie at this point in time does it lie with the Nifty IT stocks or is there more value with the midcap IT stocks, which are fallen even more?A: I haven’t looked at the midcap IT stocks that closely, but my sense is that there is great value in certain names like Infosys, Tech Mahindra. Infosys as I said is 20 percent discount on Nifty. I haven’t seen that for a long-long time and considering that this will generate some USD 1 billion of free cash flow every year, great balance sheet, good quality of management. My sense is that there is value in that stock if people are willing to play it for 9-12 months.The other stock where I see value emerging is Tech Mahindra. Hopefully there will be a stabilisation of telecom cycle coming through. May be you will not see it get reflected in FY17 numbers but in FY18 telecom cycle should pick up and they should be able to get their fair share in that capex cycle. Then that could be also stocks to watch out for.Sure, people are not seeing that signs yet but that is where stock is available in first place at 12 times. So my sense is that these two stocks can give you returns if you hold on for 6-9 months.Sonia: You briefly mentioned the impact of the rupee. This morning we are breaking an exclusive story that the commerce ministry is likely to undertake a rupee devaluation for export competitiveness? I just wanted to understand from you, which are the companies that has the highest amount of sensitivity and say how much can a 1 percent currency depreciation benefit margins for a lot of these IT companies?A: A good rule of thumb is that 1 percent rupee-dollar change beneficially impacts your margins by about 25 basis points. However, you shouldn’t do that linear extrapolation because what you kind is overtime companies do tend to pass this to the clients in the form of lower pricing or use that to make investments. In the near-term, if the rupee depreciates by 5 percent you could conceivably get a 100 basis points increase, which translates to 7-8 percent at the earnings per share (EPS) level.However, I won’t sort of extrapolate that to FY18 because history has shown that the rupee gains generally tend to get passed on to the clients. So, clients might tend to keep the beneficiary of the weakening rupee. So, don’t extrapolate that necessarily to FY18 EPS. Near-term you would see the gains for sure.Sonia: You spoke about Infosys and Tech Mahindra but you didn’t mention TCS? Recently we have seen TCS talk about a slowdown in the Banking, Financial services and Insurance (BFSI) space in North America, would you extrapolate that to the entire sector and on TCS particularly what is your call?A: In TCS, we have a neutral rating. It is not an overweight rated stock for us. It is probably a good stock to look at close to Rs 2,200 levels. These are big companies now and you are not going to be getting 20-25 percent returns on these names. When you do get 15 percent returns, my sense is that they are good enough to be owned at that point given where they are in the cycle.In that context, at Rs 2,200 my sense is that the stock is good for Rs 2,500 that is 15 percent. So it has still some way to go from there. As to whether the weakness that they have highlighted in BFSI particularly on discretionary side in the US BFSI segment, I think you have to take a little bit of a client specific approach here. Sure, worries a little bit more this time around because Cognizant has also alluded to the same weakness. So, let us wait and see.My sense is that if the interest rates do rise in the US over the next six months some banks may be positioned in the right side of the interest rate bet. In which case, they would be sitting on better profits. So, it may not be all gloom-doom if interest rates rise in the US for bank profits and for banks spending in technology. So, the notion that banks are perennially going to be spending below par than technology is not right and you just need an interest rate hike around the corner to may be change things around for select banks.Latha: You think NASSCOM cannot maintain its 10-12 percent earning expectation that will come in lower?A: So, it is 10-12 percent topline growth and my sense is that, yes having taking cognisance of two quarters of performance as of now looks like most of the companies are bringing down their numbers. So, unless we are seeing something very strong from the captives, my sense is that 10-12 percent topline growth may have to be revised downwards. I suspect that they will bring it down to between 8 and 10 percent. So, maybe you should see that in next couple of months.