Buy Mahindra Satyam, Polaris, Persistent Sys: BP Equities

BP Equities has come out with its report on IT sector. The researnch firm has assumed US$/INR rate Rs 53.4 and Rs 52 for FY13E and FY14E. Have given buy rating on Mahindra Satyam, Polaris, Persistent and Infinite Computers whereas given a hold rating for TCS, Infosys, HCL Tech, Wipro.

Weaker dollar to restrict top line in rupee terms while dollar revenue to grow moderately:

We expect the Sep quarter (traditionally one of the best) performance to be a moderate one, specifically on the volumes growth and dollar revenue growth front, however muted discretionary spending, weak demand environment and slowdown in deal flow remains top concerns for Tier-1 IT companies. We expect volumes growth for Top four IT companies to be in the range of 2-4% in Q2 FY13. Currency movement stood volatile with rupee appreciating sharply at the end of quarter however for the full quarter average stood at Rs 53.5 (appreciation of 1.0% q-o-q). Moreover, cross currency impact will be not be so significant in the quarter (only ~ 30-50 bps impact on dollar revenues growth) as USD depreciated 3.1% against Australian dollar (AUD) while appreciated 2.7% against Euro. On the pricing front we expect it to be under pressure and have taken 0.5-1% q-o-q dip in pricing. Taking all these factors into account we expect dollar revenue growth to be in the range of 2-4% for the quarter. We expect Infosys to post 3.6% q-o-q growth in US$ terms, and 6.3% in FY13E slightly ahead of its guidance (5% growth for FY13E) while Wipro to report 1.4% q-o-q revenues growth which is higher than its US$ guidance (-1.0%/0.7% q-o-q growth). However, sharp rupee appreciation of 1.0% against the dollar will impact top line, which we expect to come in the range of 1-3% q-o-q. 

Rupee appreciation and salary hikes to impact margins for IT exporters:

We expect all IT companies under our coverage to report flat to negative contraction in margins due to rupee appreciation against US$, wage hikes and high visa cost. We expect Infosys margins to expand 28 bps to 29.4% primarily due to fresher's addition, no salary hikes and increase in utilization rates. TCS is expected to report 17 bps dip in margins as gains from productivity will be offset by rise in salary, fresher's addition and rupee appreciation. We expect HCL Tech, Wipro and Mahindra Satyam margins to contract 174 bps, 143 bps and 112 bps primarily due to wage hikes and rupee appreciation. Tech Mahindra’s margins is expected to contract 264 bps primarily due to acquisition of lower margin Hutch BPO business, one time impact from cost of acquisitions and salary hikes.

Infosys likely to increase its US$ guidance however can lower rupee guidance for FY13E:

We expect Infosys to increase its US$ revenue guidance for FY13E (earlier 5% y-o-y) by 1% to 6% yo- y growth on account of recent acquisition and improvement in business environment for H2FY13. We believe, Infosys performance can revive in H2 FY13 on account of delayed ramp ups and could surprise the street on volumes front most probably in the next quarter.

Valuation & Outlook:

Global uncertainties, ongoing sovereign debt crisis in Europe and slowdown in BFSI vertical has limited further client mining opportunities within the existing top clients for Tier-1 IT companies thus limiting growth opportunities. Going forward we expect Tier-1 IT companies growth to slow down primarily due to high base effect and maturing outsourcers. Rupee appreciation remains a major concern, which can impact margins significantly. Within the large caps we expect TCS and HCL to lead the growth rate (mid teens) however currency volatility and expensive valuations limits significant upside. Select Mid caps IT companies have been able to grow faster than large IT companies primarily because of two factors 1) reduction of average deal size in the industry (TCV deals in range of US$25- 99 mn has increased significantly) and 2) Focus on a specialized domain or areas of competence. Thus we are more bullish on selected Mid cap-small cap IT space. We have assumed US$/INR rate Rs 53.4 and Rs 52 for FY13E and FY14E. We give buy rating on Mahindra Satyam, Polaris, Persistent and Infinite Computers whereas give a hold rating for TCS, Infosys, HCL Tech, Wipro.

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