While Infosys and Wipro are likely to underperform in the near term due to muted guidance, better visibility and pricing should help TCS and HCL Tech deliver improved performance, say analysts.
Disappointing results from IT bellwether Infosys had raised concerns over slowing growth for the sector. However, robust numbers from Tata Consultancy Services (TCS) and HCL Technologies last week, and in-line results from Wipro on Wednesday, confirm the concerns are unfounded. For 2011-12, with demand remaining healthy, most of these players are expected to report over 20 per cent revenue growth, though there could be some margin pressures in the interim.
While TCS and HCL Tech remain the favourites of most analysts, the latter believe there could be more pain left for Infosys’ stock. Leading brokerage house CLSA, which downgraded Infosys to outperform after results, writes in a report, “The upside from here on (in Infosys) is a matter of time, when confidence in the 2012-13 outlook takes root, and the FY12 PE multiple can expand. We suspect this will happen over time, though more gradually now that confidence in Infosys’ earnings delivery is much lower. This drives us to warn that Infosys may be a dull stock for a while. Underperformance relative to peers will drive relative de-rating.”
Most analysts are bullish on TCS due to high revenue visibility in the near term. TCS’ continued outperformance over Infosys on the operational front is a key factor in its current premium stock valuations of 10 per cent relative to Infosys. This is likely to sustain, believe analysts. Dismal results and muted guidance fuelled a de-rating of the Infosys’ EPS estimates for 2011-12 by 12-15 per cent. However, a clear management succession plan along with a pickup in volumes will be the key triggers for the company.
While Wipro is trading at attractive valuations of 18 times its 2011-12 earnings, the muted volume growth and near-term guidance are key issues. While volumes are expected to be strong for HCL Tech, the margins are expected to be around the same levels. However, management’s ability to manage key levers such as cost efficiency, employee utilisations and turnaround in the BPO segment will determine its margins.
Q4: VOLUME, PRICE GAINS
While TCS, Wipro and HCL Tech have posted robust volume growth (of 2-5 per cent sequentially) in the March quarter, Infosys’ volumes slipped due to client-specific issues such as shortening tenures of contracts. This was reflected in the muted top line growth of Infosys. Pricing, on the other hand, improved for all the four companies by around one-two per cent on a sequential basis. While currency tailwinds enabled TCS to hold on to its Ebit (earnings before interest and tax) margins of 28 per cent, a fall of 550 basis points in utilisation (excluding trainees) led to a contraction in Infosys’ Ebit margins to 29 per cent. Interestingly, TCS has narrowed the margin gap with Infosys to 170 bps. Better performance helped TCS in widening the revenue and net profit gap with Infosys, which stood at 40 per cent and 32 per cent, respectively, in the March quarter.
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| March 2011 quarter |
FY12 Estimates | |||||||
Source: CapitaLine Plus, Bloomberg
While Wipro’s Ebit margins contracted to 18 per cent, cost efficiencies helped HCL Tech improve margins by 100 basis points sequentially to 17 per cent.
Amongst the key metrics, while the BFSI segment grew for all players by one-three per cent, sluggishness in the telecom vertical continued. TCS, Infosys and Wipro also witnessed good traction in the manufacturing and retail verticals. Barring Infosys, all players were able to improve their employee utilisation rates.
Both TCS and Infosys have guided for strong hiring numbers for the full year, indicating good demand momentum. Wipro on the other hand has seen a fall in the net employee addition to 2,894 from 3,591 in December quarter.
STRONG DEMAND ENVIRONMENT
While all the players are hinting at positive demand scenario in 2011-12 due to rise in discretionary spending, margins for most companies could be under pressure in the near-term. Both Infosys and Wipro have also given muted revenue growth guidance for the June quarter of one-two per cent. Infosys expects its EPS to decline by 12-13 per cent in June quarter as well as margin contraction of 150-200 basis points. Wage rise (effective from June 1, 2011) and incremental investments will keep Wipro's margins under check. A healthy deal pipeline makes the TCS management highly confident on future good growth and it could also gain from some pricing upticks. HCL Tech is also likely to gain from the growing demand for infrastructure management services as well, as ramp up in Axon business.
