Investors can bet on larger IT companies

IT companies continue to ride along a rough patch, given the global macro-economic challenges. Though this has adversely impacted their valuations on the bourses, not all is lost for the sector.

While concerns such as lower IT budgets for ’09 and turmoil in the banking, financial services and insurance (BFSI) space remain, positive factors like increased outsourcing and offshoring opportunities and growing pie of domestic business cannot be ruled out. IT stocks have more or less followed the trend in the broader market. The ET IT index has plummeted by nearly 52% in CY08 so far, mirroring the loss witnessed by the Sensex. On a narrower time scale of the past three months, the ET IT index has declined by 30%, which is steeper than the 26% fall seen in the Sensex.

Almost all IT companies, irrespective of their revenue size, have failed to earn returns in the past three months. While four out of the sample of 90 IT companies that declared results in the September ’08 quarter earned returns during the said period, only one —Cambridge Solutions — earned double-digit returns (28%). None of the Sensex companies could fetch gains for investors during the above period.


On the operational front, the situation is even more challenging for IT companies during the current quarter, given the wild fluctuations in the rupee vis-à-vis the dollar and problems in the BFSI space. While over two-thirds of IT exports are in dollar terms, more than one-third comes from BFSI clients. Most IT vendors have shown a decline in their revenue from this space during the September ’08 quarter.

To add to their woes, auto companies in the US are in trouble. Though this will affect the order flow of some Indian IT exporters, the impact will largely be muted, as most of these companies have less than 3% revenue exposure to the auto sector. Among the top five Indian IT companies, Satyam Computer Services is likely to see greater impact since over 5% of its business comes from auto clients. Manufacturing (of which automobiles is a part) and BFSI segments together account for 40-50 % of the revenue of the top five Indian IT companies.

This means a significant portion of their revenue is currently under pressure. In the mid-sized IT space, niche players, including KPIT Cummins Infosystems, which generates over 35% of its revenue by serving auto clients, will take a hit.

Geometric, which provides product lifecycle management (PLM) solutions to auto and other manufacturing companies, is also likely to be affected. Both these companies have witnessed delays in their clients’ decisions. Apart from delay in getting new business, IT companies are also likely to witness a squeeze in the billing rates on existing and renewed projects from auto clients.

On the currency front, the average rupee-dollar rate has moved up by over Rs 2 during the December ’08 quarter so far, compared to the previous quarter. On the other hand, the average rates of rupee-euro and rupee-British pound have gone down marginally. However, the net impact of this will be dominated by the rupee-dollar relationship as majority of IT revenue is earned in dollar terms. IT companies, which consider quarterly average currency rates, are likely to witness a positive impact of currency fluctuations on their topline. This can be in the range of 3-5 %, depending on the proportion of various currencies in their revenue.

However, the currency impact is likely to be marginally negative for those IT companies which consider end-ofthe-quarter forex conversion rates if the rupee appreciates further against the dollar and moves below Rs 47 — the rate prevailing at the end of the previous quarter. IT companies are not expected to throw up any positive surprises in the December ’08 quarter and in the short term. However, the game has shifted from growth to sustainability.

As a fall-out of the economic slowdown, outsourcing and offshoring are likely to gain momentum and top Indian IT companies are set to benefit from this trend. Bigger companies have so far shown consistency in revenue growth compared to their mid- and small-sized counterparts. So, larger companies will also be the first ones to take advantage of a turnaround in the global economy, given their scale and reach. Apart from betting on large IT companies, investors can consider companies which have India-specific strategies, since the domestic economy will be impacted by the global crisis only to a limited extent.
Source - Economic Times

My View Point -
IT may see an increase in revenew as the Rupee has depreciated against Dollar.
Bad news is that its orders have become less as its recession. Not much new orders.

I am neutral on IT Sector.