IT Result Preview Apr 07

We expect the Indian IT industry to close FY07 with strong volumes. Though there has been an appreciation of the rupee against the USD, we expect the impact of the same to be mainly below the operating profit line (in other income) on account of translation losses and the open forward contracts. Hedges taken in the previous quarter will help offset the rupee appreciation effect at the revenue level. Since there has been a sharp appreciation in the rupee against USD in the past two weeks, we expect the guidance to be affected negatively for companies that give.

Our discussions with tier-I players in the Indian IT industry suggest the strong momentum will continue through FY08 as well. Indian tier-I players have continuously invested to build new verticals and service lines, which are gaining traction through their customer base. This has resulted in increasing the share of the Indian IT industry in the global market from a meager 2.3% in FY05 to 3.6% in FY07E.

Q4FY07: How will it be?
Fourth quarter results of the Indian IT services sector are expected to be steady, which will be led by higher volumes. For Q4FY07, we expect the revenues of companies under our coverage to grow 6.1% Q-o-Q and 38.7% Y-o-Y. The net profit is estimated to grow 7.8% Q-o-Q and 51.8% Y-o-Y. The growth in the net profit is higher on account of increased contribution from high margin product revenues for i-flex. The operating (EBITDA) margins are expected to increase from 25.9% in Q3FY07 to 26.4% in Q4FY07 based on slightly better pricing, improved productivity, and higher billing days. Pricing is expected to remain stable with positive bias from new and renewal business. Our coverage universe comprises of 15 companies across various technology services segments. The total market capitalisation of our coverage universe stands at USD 92.0 bn as at the end of the current quarter, compared with USD 96.3 bn as at the end of the Q3FY07.
We prefer Infosys and TCS among large-caps; in the mid-tier basket, our top picks are
iGATE Global Solutions, Rolta India, and Hexaware.

BSE IT underperformed BSE Sensex
During the quarter-ended March 2007, the BSE IT index was down by 7.1% compared with 5.2% decline in the BSE Sensex. The BSE IT index underperformed the BSE Sensex for major part of the quarter, which was mainly attributed to appreciating rupee, a concern affecting investors as well. However, we expect this to correct once Q4FY07 results and mainly the guidance from Infosys for FY08 are out, which will set the base for out performance going forward.

Infosys’ guidance: Driver of IT stock prices
Infosys’ guidance, especially in April, is an overrated event. Infosys uses data from client polling as a substantial variable in providing its guidance numbers. This means that only that business where it has visibility from orders and pipeline at the beginning of the year get captured. The orders that it bids for later in the year and are delivered within the same year get low weightage in the entire process. The table below shows the guidance given by the company (revenue and EPS) at the start of the fiscal year and the actual performance delivered by the company for that year. As is evident, Infosys has always been beating its guidance by a significant margin and
has substantially outperformed.

>>We believe that the market is currently waiting for Infosys to give its FY08 guidance, which will give an indication of the momentum witnessed by offshore scale players. The guidance will also be impacted on account of the average rupee rate for the past two weeks, which the company uses for guidance. The rate will look suppressed on account of the sudden appreciation in the same period.
>> We expect the company to guide 26-28% growth in revenues and 24-26% EPS growth for
FY08.
>> We recently met with a few business heads at Infosys and based on discussions with them, believe that the momentum across its business lines continues to be strong. In addition, many of its million dollar accounts (Infosys has 256 USD 1 mn accounts) are in the middle of scale up process. We see Indian scale players such as TCS, Infosys, and Wipro in the middle of large end-user scale up plans and are comfortable with our FY07-09 forecasts.

Rupee woes; impact analysis
During the current quarter, the rupee appreciated against the USD by 1.8%, against the Euro by 0.2%, and depreciated by 0.1% against the GBP, based on average rates for the quarter. However, this kind of appreciation in the rupee had been taken into account while giving guidance, by those who give for the March quarter.
• Guidance: We expect the rupee’s sharp appreciation to negatively impact the guidance for FY08, as most companies either use the closing rate of the previous quarter or past two week’s average rate for guidance in rupee terms.
• Current quarter numbers: We expect the appreciation of the rupee during the quarter to mainly impact the other income, below the operating level. This will be on account of the fact the open hedge positions will have to be marked to market rate on the balance sheet date. Working capital items such as debtors, cash etc., to the extent they are in foreign currency, will also be translated into Indian rupee at the closing rate resulting in a further hit. The INR/USD at the close of third quarter (December 29) was at 44.26 and during the current quarter (March 30) it is at 43.47.

Recommendation table

Company CMP (INR) Recommendation

Geometric Software 99 Accumulate
HCL Technologies 272 Buy
Hexaware 168 Buy
i-flex Solutions 2,057 Buy
iGATE Global Solutions 383 Buy
Infosys Technologies 1,921 Buy
Infotech Enterprises 351 Buy
Mastek 302 Buy
Mphasis BFL 275 Buy
Patni Computer 375 Accumulate
Rolta India 325 Buy
Sasken Communication 475 Buy
Satyam Computers 446 Buy
TCS 1,189 Buy
Wipro 518 Accumulate