IT blues linger on at Dalal Street

The information technology (IT) stock blues are here to stay. Despite a five per cent recovery on the Bombay Stock Exchange (BSE) tech index in the last four trading sessions, the IT companies "� which have been consistently posting a 50 per cent annual growth rate in terms of sales and profits in the last five years "� are losing their market value.

The average price to earnings ratio (P/E) of IT stocks "� based on trailing 12 months profits "� has declined from over 35 times in February 2007 to 23 (22.97) now. It was way back in 2003 that these stocks were trading at a similar P/E ratio.

IT AT THE CROSSROADS - IV

While other sectoral indices have been scaling all-time highs, the BSE IT index at 4,627 is still 17.8 per cent lower than the 52-week high of 5,611.33 posted on February 19, 2007

T The index is 46.7 per cent lower than the all-time high of 8,678 clocked on February 22, 2000

The current P/E is based on net earnings for the trailing 12 months (TTM) ended June 2007, while the P/E in 2003 hinged on the net earnings for the trailing twelve months ended June 2003.

Moreover, while other sectoral indices have been scaling all-time highs daily, the BSE IT index at 4,627 is 17.8 per cent lower than the 52-week high levels of 5,611.33 achieved on February 19, 2007, and 46.7 per cent lower than its all-time high levels of 8,678 clocked on February 22, 2000.

The falling market value of IT services companies can be gauged from the depleting returns in relation to the absolute increase in net profit. For instance, the net profit of the top four IT companies increased by Rs 3,415 crore during the TTM ended June 2007, while the market value increased by Rs 1,427 crore.

During the TTM ended June 2006, the net profits increased by Rs 2,836 crore, while the market value increased by Rs 101,685 crore. This means that for every rupee earned during the TTM of June 2006, the market value increased by Rs 35.85, and for every rupee of net profit reported during the TTM of June 2007, the market value has increased by Rs 0.44.

The IT stocks were comfortably placed at a P/E of over 30 times in the last three years, when the rupee/dollar exchange rate was around Rs 45-46.

The seven per cent appreciation of the rupee in the first quarter of 2007-08 impacted the net profit growth rates and market value of IT companies.

The IT sector suffered a twin blow in the last two months, with the rupee continuing to appreciate and the US subprime mortgage defaults posing a medium-term risk of IT spending cuts in the banking and financial services industry.

The IT stocks have underperformed the markets in the last one year. The BSE IT index is down by 13.8 per cent in the current calendar year against a 22.65 per cent rise in the Sensex, due to concerns about the appreciating rupee and fears of a US slowdown.

Of the top four players, Wipro is down 24.8 per cent, Infosys Technologies has shed 18.58 per cent, TCS is lower by 14.57 per cent and Satyam Computers has weakened by 10.88 per cent compared with the price levels as on January 1, 2007.

Indian IT as a business will no doubt survive, according to analysts. However, it may not command the right valuation. Take the case of Microsoft, Oracle, Dell and IBM, which were success stories on the bourses initially.

But in last four years, they are trading at P/Es of 20 and less compared with over 30-50 times during the peak of the technology boom in 1999-2000.

According to CLSA analysis, the investor focus in Indian technology stocks has shifted away from currency to core demand issues, in the backdrop of the subprime crisis.

WNS' shock revision of guidance within hours of its quarterly earnings call has exposed the vulnerability of the order book to macro shocks.

However, the analysts said that extrapolations from WNS to other technology stocks could be a mistake due to the varying client profile between the BPOs and IT vendors and IT vendors themselves.

The analysts' views on Indian tech stocks remain negative as the long term structural story in Indian IT is one of low earnings growth rate.

The growth is likely to be lower due to an increase in taxation after FY2009 and constant risk of declining margins. According to CLS analysts, the compounded annual growth rate in FY07-10 would be 20 at best for large caps, and lower for mid caps, as a result of the taxation increase in FY2010.