>TECHNOLOGY (ICICI SECURITIES)

CAUTIOUS OPTIMISM

Indian IT large-caps have been re-rated on expected stabilisation/recovery in the global economy. Signs of improvement in consumer confidence have been seen globally, leading to higher sectoral valuations ahead of fundamental upgrade. With mixed signals on global recovery, we believe the revival will unlikely be equally positive for all large-cap Indian IT vendors on fundamentals, at least in
short-to-medium term (versus pick up across total IT sector post slowdown in ’01) given depth of macro challenges, increased base, varied business concentration risks among vendors and resultant client-specific issues. This is reflected in the diverse stance by most India-based IT services vendors as regards volume pick-up & pricing decline. Hence, advice cautious optimism on IT.

■ Mixed signals on recovery in global economy. While consumer sentiment, a lead indicator, has improved in the US and Europe, key concerns are increasing unemployment, declining credit to consumers and higher debt, leading to increased savings rate among US consumers. The pace of some negative economic indicators has slowed down, indicating that the worst may be behind. Overall, sentiments and business confidence is unlikely to worsen.

■ Major pick up in IT services volumes is unlikely before H2FY10/FY11 with IT services growth lagging corporate profitability growth by ~2 quarters, in our view.

■ Likely stabilisation of global economy to cap valuation downside in medium-tolong term. We believe that newsflow on global economy may not be significantly negative and, therefore, large-cap IT sector will be a direct beneficiary and recent P/E re-rating versus our earlier forward target P/E of 11-13x for Infosys, Tata Consultancy Services (TCS) and Wipro is likely to sustain over the medium-to-long term. But we are surprised by the pace of P/E re-rating and believe that there is less room for further upside in the short term. We raise our target price on revised forward FY11E target P/E of 12-16x.

■ Sectoral strategy. Recommend staying selective based on: i) higher earnings visibility of vendors versus peers and ii) increased diversification in services/vertical portfolio to gain higher wallet share given the cautious recovery in IT spend. Hence, reiterate Infosys (upgrade to BUY from Hold) and Wipro as our sectoral picks over TCS as we believe that concerns about client-specific issues and relatively lowmargin levers still persist for TCS. Though we maintain HOLD on HCL Technologies on short-term execution challenges, we rate it as a dark horse in the sector. We also
upgrade Patni to BUY on lower valuation downside and earnings risk.

■ Key risks are: i) significant rupee appreciation after likely stable political scenario in India ii) increasing protectionism in the US and Europe and iii) delay in client decision making beyond H1CY09.

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