KRChoksey report on IT sector
BSE IT index outperformed general indices on back of weakness in Rupee Over the span of last 6 months BSE IT index has significantly outperformed general index i.e. SENSEX. For instance, BSE IT index has run-up by 33% versus 16% increase in SENSEX in last 6 months. We believe the primary reason of outperformance is Indian Rupee depreciation against USD by 5% during that time frame.
Demand environment remained status quo over the span of last 6 monthsOverall demand environment for Indian IT companies remained unchanged over the span of last 6 months. For instance, Cognizant has toned down its revenue growth guidance for CY14 from 16.5% YoY to around 14% YoY and TCS management expects in-line growth rate (on organic basis) in FY15E as compared to earlier expectation of outperformance versus FY14.
What next? With BSE IT index near its all time high level; we believe exercise of doing reverse DCF for Tier I Indian IT companies will enable one to know whether growth rate and margin level built in stock price is conservative or aggressive.
Reverse DCF indicates in case of TCS and Infosys at the current price level mid-teen revenue CAGR is built in the price over the period of FY18E to FY27E; assuming modest decline in EBITDA margin (30 bps per annum) over same time frame and terminal growth rate of 5%. Wipro’s current share price factors in revenue growth of 12% (in USD terms) in second phase of growth (i.e. FY18E to FY27E) and decline in EBITDA margin by 30 bps per annum. For HCL Technologies revenue CAGR (over the period of FY18E to FY27E) built-in the price is 10%; assuming dip in EBITDA margin by 50 bps YoY and terminal growth rate of 5%.
Preference for companies where there is scope for positive surprise compared to expectations built-in stock price"Considering revenue growth rate built in stock price during phase II (i.e. FY18E to FY27E) and margin expectations; we prefer HCL Technologies followed by Wipro. Whereas, in case of Infosys we believe recent spike in stock price leaves little on table for investors. TCS’s stock price has built in highly optimistic scenario and hence we recommend REDUCE on the stock inspite being consistent outperformer in terms of revenue growth rate versus industry’s average", says KRChoksey research report.
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