IT stocks: Fully valued

With the possibility of the rupee appreciating further, it's still too early to bet on the sector.

The year 2007 has been a nightmare for the technology sector. The BSE IT Index, which started the year at 5369, dropped to a low of 3959.90 in late November before gaining 6 per cent on Monday to hit 4581.61.

Since November 22, the index has risen 15.7 per cent, and with a few more days to go, the sector might not end the year as badly as it did in 2001.

Even as economists talk of a mild recession in the US, 2008 could turn out to be a better year for IT companies than what is being anticipated. Despite a slowdown in the US, spending on technology may not fall too much as it did in 2001-02.

However, the companies will have to post strong revenues in order to absorb the higher cost of wages and offset the rupee appreciation.

As of now, there is little to indicate that the top-rung companies will not be able register a revenue growth of 25-30 per cent in rupee terms in FY09. In fact, a mild recession in the US may lead to an increase in outsourcing activities.

However, while most technology firms were able to negotiate better prices with new customers in FY08, it may not be possible in FY09 when the attempts will be to maintain prices.

Since Indian IT vendors have a fairly high exposure to the BFSI sector, they will need to get good billing rates from this vertical.

According to some reports, a couple of big BFSI clients have already managed to extract pricing cuts, which is not a good sign. However, there are a few such instances. Things will be clear only by April as slowdowns usually come to light in February-March.

The earnings growth of the top five IT players in the next three years should be in the region of 19-20 per cent compounded. Valuations have already been adjusted and most stocks are trading in the region of 17-18 times forward compared with 25-26 times a year ago.

Even at these levels, however, the risks still outweigh the rewards given that the rupee could appreciate by another three-four per cent.