>INFORMATION TECHNOLOGY: Operating leverage at play

We recently met the managements of TCS, Infosys, Wipro and MindTree, respectively, to gauge their earnings risk. The commentary was consistent across companies. There are no warning signs from the clients’ IT budget as yet. The currency depreciation is going to result in operating margin tailwinds, but crosscurrency movement could be a spoil-sport for revenue growth in USD terms. However, in the quarter where the revenue performance is likely to be bunched-up, we expect the companies with better operating leverage to deliver stronger growth at the bottom-line. We expect stronger‐than‐peer performance for Infosys and HCL Tech as we enter Q3FY12. Hence, we reiterate Infosys and HCLT as our top‐picks.


■ Volume growth likely to be bunched up: Based on our recent discussion with the management, we expect Tier-1 Indian IT companies to deliver low-to-midsingle digit volume growth. The growth pack is likely to be led by Infosys and HCL Tech, whereas we expect Wipro to continue lagging behind its peers. However, cross-currency exposure would differentiate USD performance for the companies. We see Wipro and TCS as the worst affected due to high rupee and GBP exposure.


■ Operating leverage would drive positive surprise: This quarter has witnessed the strongest tailwind from the currency depreciation ever (excl Q3FY09). We expect Indian IT companies to see tailwind of ~300bps in Q3FY12. However, due to higher hedge, book positions of TCS (US$2.6bn) and Wipro (US$1.7bn) would be a drag at the bottom-line. Moreover, stretched margin levers of Wipro and TCS would result in margin erosion at constant currency terms. We expect Infosys and HCL Tech to deliver stronger quarter as these two are better placed in terms of operating leverages. However, aggressive pricing by HCL Tech to gain market share could yield negative surprise on operating margins.


■ Infosys and HCL Tech – remain our top‐pick in the sector: Our recent discussion with the companies’ management indicates no signs of cut in the IT budget. The companies maintained a cautious tone due to uncertainties in Europe, but highlighted no early signs of any cut in IT budget for CY12. We expect the
current quarter performance to be differentiated based on the operating leverage. We see that Infosys and HCL Tech are advantageous as compared to TCS and Wipro in terms of exploiting these leverages. We reiterate Infosys and HCL Tech as our top‐picks in the sector.


To read the full report: INFORMATION TECHNOLOGY
RISH TRADER