Monday, October 4, 2010

IT Services Sep’10 Result expectations: Beat on solid expectations

      Strong revenue growth to confirm positive demand momentum

We expect strong revenue growth across the entire Tier I coverage universe to confirm the positive demand momentum for India techs as we build in a volume led 6.3-7.9% sequential US$ revenue growth for the Tier I universe (aided to some extent by QoQ cross currency gains in the range of ~70-110 bps, refer table below for Sep'10 expectations). We expect both Infosys and Wipro to surpass their respective revenue guidance's for Sep'10 as we factor in a 7.9% QoQ growth for Infosys (revenues of US$ 1,466 mn, +7.9% QoQ, V/s co's guided range of US$ 1,413-1,427 mn) and ~6.3% sequential growth for Wipro (revenues of US$ 1,280 mn, +6.3% QoQ V/s co's guided range of US$ 1,253-1,277mn). 

Margin performance to vary across Tier I's on a/c of wage increments/promotions for HCL Tech, TCS and Wipro

We build in ~190 bps sequential improvement in margins for Infosys however expect margins (1) to be near flat for TCS and Wipro (on a/c of promotions linked wage increments for TCS and RSU linked hikes for Wipro) and (2) to be down by ~190 bps sequentially for HCL Tech ( on a/c of wage increments implemented during the quarter) despite solid revenue growth and favorable currency during the quarter(despite the sharp appreciation in US$/INR towards the fag end of the quarter which should lead to significant translation losses below EBITDA line for Indian techs). In case of Tech M, margins should be up by ~30 bps sequentially to 19.1% as wage increment impacts get spread over two quarters.

Expect Tier 1's to outperform Tier II's on both revenue and margin performance

Although we build in decent revenue growth for our Tier II coverage universe as well (+4.7-9.5% QoQ growth), Tier II's would still lag behind Tier I's both on revenue growth as well as EBITDA growth (note that YoY EBITDA growth for most of the Tier II universe is flat to negative except for eClerx vis a vis high teen comparable for all the tier I universe ex HCL Tech).

Expect upgrade in Infosys's FY11 revenue and Profit guidance

Despite the sharp appreciation in the INR towards the fag end of the quarter, we expect Infosys to raise it's INR EPS guidance to Rs 117-120 (+7-9% YoY growth, V/s ~3-7% growth guidance earlier) driven by a reset in US$ revenue guidance to 22.5-24.5%( V/s 19-21% YoY growth guidance earlier).  However we would like to monitor the Sep'10 results for (1) any early indications on CY11 budgets and a pick up in discretionary spending (recent news flow/comments have been positive from global players like Accenture), (2) key operating metrics like attrition, employee hiring and utilization rates , (3) pricing outlook (recent commentary has continued to be positive on this front from offshore vendors) and (4) increase in hedging/changes in hedging policy( remains the key risk to earnings estimates if INR were to appreciate further)

We currently have ACCUMULATE ratings on Infosys, HCL Tech and TCS (with our order of preference in the same order) and a REDUCE on Wipro.

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