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But this could change as select large IT firms struggle to beat heightened investor expectations, while mid-sized peers continue to remain on course. “We are downgrading our sector recommendation for the Indian IT from “neutral” to “underweight” as we watch the margin of safety in Indian IT stocks recede,” according to FII brokerage CLSA.
In a controversial call taken in late June, the brokerage said it expects tier-1 companies to slide through the June quarter results but are unlikely to show any material proof points. The brokerage feels that through the past decade, valuations of Indian IT companies have slowly contracted from 25-26 times one-year forward earnings in 2006-07 to 20-21 times now.
The IT index has underperformed in the April-June quarter as the January-March quarter panned out to be a soft quarter because of clients freezing their budgeting cycles. However, the demand outlook for IT spending remains positive as clients look forward to spend on discretionary services such as enterprise solutions and engineering services to drive cost efficiency, prepare for growth and capture market share.
In such a scenario, both large and mid-sized IT firms could benefit. But to be fair, mid-sized IT firms have historically shown patchy performance, which investors have not liked. In addition, their small size has meant that a single large client loss can potentially impact earnings by a larger extent compared with a large IT rival.
For example, the top three large IT companies (TCS, Infosys and Wipro) have more than Rs 20,000 crore in annual revenues, while the largest mid-cap IT stock, MphasiS, usually makes around Rs 5,000 crore a year in sales. The smallest mid-cap IT firm, Sasken, rakes in just Rs 500 crore.
But that said, revenue growth of mid-sized IT firms has been strong for those who have already declared numbers for the June quarter, while the Street estimates are pretty good for others who still haven’t.
For example, banking and insurance software firm Polaris’ June quarter numbers show a US dollar-denominated revenue growth of 4.1 per cent quarter-on-quarter led by similar revenue growth in products and services. An earnings before interest, taxes, depreciation and amortisation (Ebitda) margin increase of 82 basis points quarter-on-quarter was higher than what analysts expected.
Arun Jain, founder, chairman and chief executive officer, Polaris, said three years ago, the company set a mission of “repeatable predictable and profitable growth”. Polaris expects revenue growth between 22-25 per cent in the coming year, ahead of the industry growth average, which Nasscom predicts could be 16-18 per cent year-on-year.
Bangalore-based MindTree saw revenue growing by 7.3 per cent quarter-on-quarter to $92.53 million in the June quarter. Its profit after tax (PAT) increased by 9.7 per cent quarter-on-quarter to $7.73 million. “Momentum in both our businesses (IT services and product engineering services) is expected to continue and we are confident of delivering higher than industry average growth in FY12,” said Krishnakumar Natarajan, CEO and managing director, MindTree.
Another mid-sized IT firm, Infotech Enterprises, revenue for the June quarter rose 7.8 per cent quarter-on-quarter with strong 4.4 per cent volume growth from both its verticals – network and content engineering (N&CE) services. Like their larger peers, most mid-sized IT firms saw margins being hit due to wage hikes and tax benefits, which were withdrawn from April 2011 onwards. However, management commentary has been bullish - in contrast to the cautious words from managements of TCS, Infosys and Wipro.
Shrishti Anand, IT analyst, Angel Broking, said, “Among mid-tier IT companies, profitability is expected to slide steeply because of wage hikes, as well as shooting up of tax rates due to the expiry of STPI (Software Technology Parks of India) with effect from April 1, 2011. However, this was already priced in our estimates.”
Ravi Pandit, chairman and group CEO of KPIT Cummins said, company is confident of achieving growth objectives for the year, despite the existent macroeconomic uncertainty. KPIT’s US dollar revenue for the June quarter grew 6.99 per cent quarter-on-quarter to $70.09 million.
Anand Deshpande, chairman and managing director, Persistent Systems, also feels that FY12 has started on a very positive note for the company. “Growth is the theme common across all our customers, and with our wide footprint across the software technology eco-system, we continue to be the catalyst for growth for our customers,” said Deshpande. Persistent Systems clocked $50 million in revenues for the first time in a quarter.
This month, Hexaware bagged a $177 million deal, the third large deal signed in the past three months. With positive deal flow, such as these coming through, analysts say that this indicates that mid-sized companies are getting attention from customers. However, it would be foolhardy to believe that mid-cap companies will not have any problems. In the June quarter, experts are expecting a few mid-sized companies to underperform on the revenue growth quarter-on-quarter.
“Smaller companies in our universe are likely to lag, with MphasiS (3.4 per cent quarter-on-quarter) struggling to see traction in the HP channel. Tech Mahindra (3.5 per cent quarter-on-quarter) is seeing little respite within telecom spends and Patni’s (2.3 per cent quarter-on-quarter) comments indicating that concerns on ramp-up across key accounts will continue to pose a challenge,” said Kuldeep Koul of Motilal Oswal. zz
kumarsroy@mydigitalfc.com
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