>Indian IT services (CITI)

4QFY09 Preview: Muted Quarter; FY10 Outlook in Focus

* Infosys FY10 guidance in focus; “buy side” expecting ~2.5% revenue decline — Investor focus will be on Infosys’ FY10 guidance. We believe the company is likely to guide to a revenue ($-term) decline of ~3-5% YoY – which is not too different from buy-side expectations of ~2.5% decline, as per our recent investor survey. With the quarter end exchange rate at ~Rs50.5/$, our analysis suggests that Infosys is likely to guide to flattish EPS (for details see:

* Most challenging quarter for Indian IT till date — 4Q will be the first quarter of revenue declines (even in constant-currency terms) across the board. Pricing should come under further pressure – a trend likely to continue over the next few quarters. We expect Tier-I companies to report ~2-3% QoQ revenue decline ($- terms). INR depreciation should partly offset the pricing-related margin pressures.

* Another quarter of significant currency moves — The sharp currency moves witnessed in 4Q (not as sharp as 3Q though) will result in: (1) Negative impact on $-term revenue growth due to the adverse movement of $ against GBP. (2) Positive impact of depreciating INR (against $) on the margins of companies. (3) Forex losses on account of hedge positions.

* Focus on margin defence — In our recent conversations, Tier-I companies seemed confident on maintaining margins in FY10 due to: (1) Offshore shift of revenues; (2) Lower variable payouts; (3) Favorable INR; and (4) Lower travel/communication costs, etc.

* Infosys best placed for depreciating INR; HCLT for appreciating INR — Due to lower quantum of hedges and no losses on balance sheet, Infosys is relatively better placed in a depreciating INR environment. On the flip side, HCL Tech has huge losses (~$207m at end of Dec’08) on its balance sheet and benefits more if INR appreciates.

* Sharp run-up leaves room for disappointment — From a near-term point of view, the sharp rally over the last month or so leaves little room for disappointment. Demand environment remains very challenging with no signs of recovery yet. Longer term, we wait for stability in business before becoming more positive on the sector.

To see full report: INDIAN IT SERVICES