IT sector update: Emkay

Emkay's report on IT sector update

"We raise our earnings estimates for Tier I coverage universe by 1-5 percent and 0-5 percent for FY14/15 respectively driven by our revised currency assumptions (Rs 55.3/USD for FY14 and Rs 54/USD for FY15 respectively, refer table below in the section). Similarly our earnings estimates for our Tier II coverage universe stand raised by 0-4 percent and 1-6 percent respectively for FY14/ 15 respectively on lower currency assumptions. We highlight that we do not model in complete flow through of currency led gains into margins/earnings as we believe that companies will continue to reinvest INR led gains back into the business either in the form of higher sales and marketing investments or pass on the currency led gains back to the client in the form of lower pricing as has been seen through FY11-13(refer section below). We also do not build in meaningful margin improvements led by currency support for our Tier II coverage universe unlike the past 18 months (margins for a number of Tier II players has improved in the past 8 quarters as compared to Tier I players who have not been able to gain from the currency depreciation)." "We continue to retain our 'selectively positive’ thesis on the sector with Infosys (BUY, TP Rs 2,900) and HCL Tech (ACCUMULATE, TP Rs 870) being the top picks in the Tier I universe. We also upgrade our ratings on Wipro to HOLD with a revised TP of Rs 360 (V/s our long held REDUCE rating earlier) given inexpensive valuations at <13x/12x FY14/15E P/E and limited downside to consensus estimates ahead in our view although a positive case for the name remains hinged on catch up on growth with peers which has remained elusive through FY10-13. Wipro has addressed some of the inherent weaknesses related to account mining since the management change in early CY11( note that revenues from top 10 clients grew by 16 percent for Wipro in FY13 as compared to ~5 percent for Infosys and TCS, who historically have done better at mining historically). Amongst the mid tier names, we continue to like TechM / Mah Satyam (ACCUMULATE, TP Rs 1,100/130), Hexaware (BUY, TP Rs 105), eClerx (BUY, TP Rs 815) and Mindtree (ACCUMULATE, TP Rs 960). Both Mindtree and Hexaware in our view are good tactical bets for decent stock returns in the near term. However the US Immigration Bill (currently under debate in the Senate and most likely to be passed before July 4’2013) remains a possible overhang for the offshore IT Services space, a moderate improvement in client spending environment (V/s CY12/FY13) coupled with sharp currency depreciation makes up keep the faith on our positive ratings on the above names. We raise our FY14/15E earnings higher by 1-5 percent/0-5 percent for our Tier I coverage based on our revised currency assumptions (Rs 55.3 for FY14/54 for FY14 respectively). Similarly we raise our earnings estimates for our Tier II coverage universe by 0-4 percent/1-6 percent respectively for FY14/15 (refer table below for revised earnings estimates for our coverage universe). We note that we do not build in a complete flow through of currency led gains into our margin/EPS assumptions as we see companies passing on currency led gains either back to the client or reinvesting in their businesses either in the form of hiring more client facing/domain experts. There is ample evidence to that effect through FY11-13 wherein all Tier I players albeit for HCL Tech (margin profile was considerably lower than other Tier I peers) did not report any improvement in margins despite ~20 percent currency depreciation during the period," says Emkay Global Financial Services research report. Disclaimer: The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

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