How the US tax cut can benefit Indian IT firms

Also, a strong dollar can improve revenue growth in FY19

The approval by the US Senate for tax cut Bill is expected to spur investments in the US and rub off positively on Indian IT companies. The sector, which is struggling with sluggish demand from clients in the US, could benefit once the Bill, which envisages a reduction of corporate tax to 20 per cent from 35 per cent, becomes a law. This is expected to happen in the March quarter of 2018. Despite weak broader markets, most IT firms, barring Wipro, ended in the green on Wednesday.

Analysts at Credit Suisse say business investments are likely to be immediately boosted by tax cuts and new depreciation rules. CEO confidence surveys, according to them, are signalling optimism, partly based on expected increases in future post-tax earnings. In fact, if the Bill delays tax cuts until 2019 but enacts generous depreciation rules in 2018, the incentive to invest immediately will be even stronger, they added. 

The tax rate cuts are also expected to lead to a stronger dollar, which would boost realisations of Indian companies. However, the real gains would depend on how much the domestic companies can retain, as they will also have to pass on some of the benefits to customers to garner higher volumes. Outside the tax cut Bill, there may also be some additional costs if minimum wages for IT workers are increased in the US.

Analysts at Spark Capital say sectors such as banking, financial services and insurance (BFSI), telecom and retail are expected to start spending more on customer acquisition and thereby, drive IT spends. If the investments lead to higher demand, brokerages could revise their existing FY19 revenue growth estimates for IT majors from 7.5 per cent to 10 per cent in dollar terms, while earnings growth, too, cold see an uptick from the current estimates of under 5 per cent.

While all IT companies, given their high US exposure, will benefit, Spark Capital’s analysts highlight that Infosys, TCS and L&T Infotech as being among the beneficiaries. Among the larger IT vendors, HCL Technologies derives about 11 per cent of its FY17 net profit from its US subsidiary, while for others the figure is between two per cent and seven per cent. 

Morgan Stanley analysts said the main triggers for the sector and stocks could be led by an uptick in BFSI spending where management commentary has been positive, faster scale-up of digital (currently about a fifth of revenues but is growing at 25-30 per cent year-on-year) and the rupee depreciation due to any geopolitical events.

The only downside in the Bill is changes to the Affordable Care Act, which might impact health care spending. This a key vertical for Wipro, as it contributes 15 per cent to its revenues.