>INDIAN TECHNOLOGY: EU-‘phoria’ or EU-‘phobia’ – Part 2

We reassess the risk associated with the revenue exposure of Tier-1 IT companies to Europe. HCL Tech (HCLT) has not only got the highest exposure, but also its top-10 clients’ revenue has got highest exposure to Europe. However, the current cost pressure has increased acceptability towards outsourcing. We believe that Indian IT Services companies will be benefitted from the current macro-economic environment of Europe. We reiterate Tier-1 IT companies as our top pick.

■ HCLT – sailing steadily in troubled waters: HCLT, among Tier-1 Indian IT Services Companies, has got the highest exposure to Europe. HCLT drives ~26% of revenues from Europe. In addition to that, their top 10 clients have got the highest exposure to Europe. HCLT’s top 10 clients derive 55% of their revenue from Europe, posing revenue risk for HCLT. However, winning strong new deals and mining non-top 10 clients helped them deliver stronger-than-peer revenue growth. We believe that HCLT would continue to deliver stronger-than-industry average growth as discretionary spend in Europe show signs of recovery.

■ Global Tech majors indicate increase in global discretionary spend and European recovery: Quarterly results of Accenture, Oracle and SAP indicated an increase in the discretionary spend across the board, along with strong demand recovery in Europe. Accenture’s consulting revenue grew by 9.1% YoY, whereas Oracle and SAP licenses revenue grew by 14.2% and 11.4% YoY, respectively in the most recent quarterly results. Moreover, European revenue for Accenture, Oracle and SAP grew by 3.9%, 30.7% and 6.5% YoY, respectively. A strong performance by tech major is the lead indicator of strong demand recovery in Europe. We believe that cost conscious Europe would increase outsourcing, benefiting Indian IT companies.

■ Cross currency movement – margin headwinds tough to contain: According to our estimates, Euro/GBP depreciation against USD will have ~1-1.5% impact on USD terms revenue. Moreover, rupee appreciation against USD, EUR and GBP by 0.7%, 8.7% and 5.1% QoQ, respectively would create a margin headwind of 95- 110bps QoQ. We believe that a wage hike, along with currency headwind, will have 50-100bps impact on the margin.

■ Reiterate Infosys as our top pick, accumulate HCLT on declines: We advocate owning structural winners and in this context Infosys remains our top pick, given least revenue exposure to troubled economy. We believe HCLT’s recent underperformance (down 10% since Q3FY10) represents a buying opportunity for investors. Trading below 16x our FY11e EPS (~20% discount to tier-1 Indian IT), we think the market has now factored in too many negatives ignoring strength in new deals win.

To read the full report: INDIAN TECHNOLOGY