>Indian IT services (CITI)

IT Services Beat

Hopes of Global Recovery Partly Priced In

■ Stocks pricing in partial recovery — Tier I stocks have outperformed the market by ~5-15% YTD despite a poor 4Q and muted outlook; due to weak INR and expectations of a recovery. We believe stocks are running ahead of fundamentals.

■ Mixed view on 2H outlook; turnaround could result in some upside … — Some “green shoots” globally have resulted in hopes of a rebound. Difficult to time a turnaround; has to happen at some point given revenues are declining every quarter. Clarity on turnaround could result in some multiple expansion.

■ … but slow EBITDA growth over FY09-11E to limit this — Muted sub-10% growth in EBITDA over FY09-11E (assuming a reasonable recovery) and size issues constraining growth post that, sustainable expansion in multiples looks unlikely.

■ Changes to estimates/target prices/risk ratings — We are raising our multiples slightly given that FY10 is likely to be a trough year and the likelihood of global recovery in CY10 seems higher than in the past. High FCF yields should support valuations; our target prices are now based on Sept’09 multiples.

■ Sector defensive but upside limited; Downgrading TCS; Infosys preferred pick — On a relative to market basis, strong FCF yields for Tier-I stocks make the sector a good defensive. However, lack of growth will limit upside, in our view. Downgrade TCS to Sell. Infosys is our top pick; HCL Tech is relatively inexpensive.

To see full report: INDIAN IT SERVICES