Tuesday, May 25, 2010

>Information Technology – ‘Margin headwinds’ (INDIA INFOLINE)

Exemplary margin performance over the past two years despite multiple headwinds
Operating margin of the Top 3 IT companies (Infosys, TCS and Wipro) has been resilient over the past two years despite multiple structural headwinds such as flattish volume growth, sharp
correction in pricing and rupee appreciation. Over the past seven quarters, TCS, Infosys and Wipro have improved their margin by 6ppt, 3.5ppt and 1.2ppt respectively, which is commendable. Infosys and TCS recorded their multi-quarter-high margin in Q3 FY10 and Q4
FY10 respectively. Wipro’s margin management has been relatively weaker though.

Offshoring, fixed priced project shift and utilization improvement were the key operational levers
Offshoring driven by both vendors and clients played a pivotal role in supporting margin. It was handsomely utilized by TCS whose offshore revenue contribution increased by 10ppt, significantly higher than Wipro (4.5ppt) and Infosys (1.2ppt). The large IT players also leveraged their experience and expertise in timely execution of projects by taking-on more engagements on fixed priced basis and they were successful in deriving higher productivity/efficiency. Wipro was the most active with a substantial 14ppt fixed price revenue
shift while Infosys and TCS improved their fixed priced revenues by 7ppt and 6ppt respectively. Employee utilization improvement was another key operational lever that enabled margin expansion as companies reduced their bench size and hired cautiously.

Organization-wide cost control also supported margin with SG&A% remaining flat over the past two years.
Margins have peaked-off for the Top 3; adverse currency and wage inflation are key headwinds
After surprising the street on margin performance over the past many quarters, the Top 3 Indian IT vendors face a tough margin scenario ahead. Margin in the short-term would be impacted materially by significant headcount addition in the past two quarters, wage hike implementation (offshore 8-12% & onsite 2-4%) and annual promotions, rupee appreciation and adverse cross currency movements (strengthening of US$ v/s GBP and Euro) and significant
investments in S&M to exploit the improved business scenario. Though revenue growth is expected to get stronger, employee utilization would likely correct for Wipro and TCS as it is currently above trend. A further increase in attrition, which has jumped recently, could also start impacting the profitability. On the other hand, margin support may only come from further fixed priced project shift and offshoring though these may not continue at the pace seen in the past few quarters. Over FY10-12E, we expect a margin decline of 100-250bps for the Top 3, the lowest for Infosys due to its benign employee utilization and superior margin management track-record.

Continue to prefer Infosys amongst the large players
With Infosys offering more resilient margin and superior revenue growth over FY10-12E, we continue to prefer the stock over TCS and Wipro. Absolute returns from these stocks could be capped in the near-term given their significant outperformance v/s broader market in the past 12 months and fundamental overhang from margin headwind and Europe crisis.

To read the full report: INFORMATION TECHNOLOGY


Strong VSF performance drives 16.9% yoy revenue growth; beats expectations

OPM surges 360bps yoy despite weak operational performance by the cement division

PAT grows by 56.7% backed by higher margins and lower tax outgo

To read the full report: GRASIM INDUSTRIES

>INDIA TELECOMMUNICATIONS: 3G Auctions Done; Bharti Is Our Key Pick for Four Reasons

We upgrade our view on the India telecom industry to In-Line for three reasons: 1) The 3G auction is behind us; 2) tariff wars seem to have subsided; and 3) the F4Q10 results surprised us as they show revenue growth driven by higher minutes of usage (MOU).

The 3G auction concluded at the end of day 34 of the bidding and 183 rounds. The overall license fee stands at Rs168bn (US$3.6bn), up 379% from the reserve price of Rs35bn (US$755mn). Bharti, Aircel, and RCOM won 3G bids in 13 circles each, Idea won in 11 circles, and Vodafone and Tata won in 9 circles each. We estimate the government could raise ~Rs921bn
(US$20bn) from the 3G and BWA auctions or 1.2% of the country’s GDP.

Tariff wars behind us: In the five months since the launch of “per-second billing” by Tata and the “Simply Reliance” plan by Reliance Communications (which lowered all tariffs by 30%), we have not seen any further reductions in tariffs in new launches. Most of the players now have similar tariff packages. Hence, there is not much differentiation for a consumer to choose one operator over the other, barring nationwide footprint and service. However, post-paid tariffs are still costlier than pre-paid tariffs, and we expect them to fall in the next quarter.

Higher MOUs drive F4Q10: The group posted revenue growth of 1.7% QoQ; and absolute EBITDA stopped falling. The growth was driven by overall minutes, which rose 11% sequentially and over 30% YoY. Capex fell to 15-20% of sales; down from over 30% YoY.

To read the full report: INDIA TELECOMMUNICATIONS


Loan assets were up 30% yoy; exposure towards private sector entities has increased to 6.5%.

Sanctions grew at a modest 11% yoy rate; disbursements, however, remained healthy at 23% yoy.

Margins improved on account of lower cost of funds. Higher pricing power and increasing private sector exposure would enable maintain margins at current levels.

Net interest income was up 48% yoy, net profit too reported a sturdy 45% yoy growth.

Infra-financing nomenclature to enable increase exposure limits. Maintain BUY.

To read the full report: REC