Indian information technology (IT) firms are currently in an environment of healthy revenue growth. This is being fuelled by higher discretionary spending by companies in the US, and the increased profitability of European who are renewing their interest in investing in IT. The quality of business for the Indian IT firms also seems to be good. The return on equity (RoE) for many of these firms is good; there is little to no debt; and cash flow steady. A stable rupee is another positive.
Revenue Momentum Robust
According to the IT industry lobby group, NASSCOM, IT exports are expected to grow at 13%-15% Y/Y in dollar terms in FY15, with growth momentum led by clients in the both US and European markets.
Indian IT firms have also steadily increased their revenues from ‘newer service lines’. Over the past few quarters, revenues of IT firms from Europe have grown more than the previous eight-quarter average. This growth has been led by the need for cost cutting by European corporations. Secular growth in Europe is a positive. Given that Europe contributes around 30% to revenue, this could be a key driver going forward. The two largest markets (US and Europe), which contribute 80%-85% to revenue are seeing strong growth, lending confidence to expectations of healthy revenue growth continuing through FY16-FY17.
The stable currency is a big positive for the sector. Over the past few years, the rupee has depreciated against the dollar, which has been the tailwind to fight margin headwinds. Even post the general election 2014 results in May 2014, the rupee has not appreciated and has traded in a range. This is a positive for Indian IT. Post the 2008-09 financial crisis, there has been a notable polarisation in revenue growth of Indian IT firms as clients became more demanding. TCS and HCL were able to adjust faster to the ‘new normal’ business environment. This polarisation could continue in FY15-FY16, even as the magnitude could get reduce by FY16, as Wipro and Infosys start to show improved growth. Analysts expect TCS to record a high 17% dollar revenue CAGR over FY14-FY16, despite its considerably larger revenue base compared with peers. HCL (15.8%), Infosys (10.%) and Wipro (11%) form the chasing pack.
All four frontline IT stocks seem attractive in different ways. HCL’s revenue and profit growth is consistent, and valuations reasonable. Wipro’s profile is fast improving with several big-ticket contract wins. The appointment of a first ever non-promoter CEO has raised expectations from Infosys, while TCS has been by far the best performer in terms of revenue growth over the past several quarters. We take a closer look at each of these four blue-chip IT stocks.
TCS is India’s largest software services company, with $13.4 billion in revenues in FY14. The company is an end-to end IT and BPO company, offering services such as software development, maintenance, consulting, testing, IT infrastructure management, systems integration and BPO. TCS offers these services to industry verticals like financial services, manufacturing, retail, telecommunications, life sciences and energy and utilities. TCS derives a majority of its revenues from the North American market. The company has grown its consolidated revenues, EBITDA and net profits at CAGRs of 24.1%, 28.5% and 29.9%, respectively over the period FY09-FY14 and had a total of over 305,000 employees on its rolls at the end of June 30, 2014.
TCS has grown its dollar revenue at a 3.9% CQGR over the past eight quarters, ahead of peers, reflecting admirable consistency. A key aspect is the broadbased nature of growth. TCS has driven a good balance between focus on bread-and-butter businesses and investing in newer growth avenues.
TCS could maintain its growth model for 16% dollar revenue CAGR over FY14-FY17. The sharp polarisation in top tier IT firms’ performances could continue over FY15-FY16 and TCS’ stock could continue to command premium valuations.
However, due to its already steep valuation, the upside for investors who wish to get in now could be limited compared to ther IT stocks.
Infosys has always received disproportionately large media coverage due to a variety of reasons. In the recent years, the coverage has been less than flattering for a company that was used to a fawning press. There are high hopes that Vishal Sikka, the newly appointed and first non-promoter CEO of Infosys will put the zing back in the company. It is hoped that he would drive higher revenue growth through improved client mining, better access to Fortune 500/Global 1000 accounts and use the company’s cash reserves more proactively.
Sikka operating from the US is a positive factor, given that he is based geographically close to its client offices. Infosys could also become more proactive in its cash usage. The IT major has hitherto been very conservative on this front and has rarely made any major acquisitions with the nearly $5bn cash pile on its balance sheet. Infosys could start to become more active on the acquisition front, adding key capabilities and also improving RoE.
The stock trades at a significant 29% discount to TCS. This discount could narrow, led by improved revenue growth. Apart from this, it is important to reduce the high attrition rates, an issue that Sikka has started to address by awarding 5,000 promotions in August 2014. Improved revenue growth and lower attrition could be key triggers for a stock re-rating.
Wipro’s Y/Y dollar revenue growth trajectory has been improving for the past five successive quarters now. The IT major’s deal wins with marquee names like Philip Morris, Saudi Electricity and ATCO inspire confidence as far as revenue uptick is concerned. A major highlight for Wipro was its $1.1bn ATCO deal win in July 2014, implying annual revenue of $112mn over the next 10 years. This, along with improving growth in the key global infrastructure services business (highest Y/Y growth in 1QFY15 in 11 quarters) strengthens optimism of the continued revenue growth turnaround. Wipro’s stock currently trades at a steep 32% discount to top tier IT peer TCS. With robust revenue growth this gap will significantly narrow.
Wipro has also shown impressive margin management, aided by utilisation increase and cost efficiencies. On client metrics also, Wipro has done a good job in terms of client mining, with its annualised revenue per client having risen on a Y/Y basis for the past 23 successive quarters.
Improving growth and attractive valuation suggest there could be a 17% or thereabouts upside to the stock in the next one year or so.
HCL Technologies (HCL) is India’s fifth-largest IT services company, with revenues of US$5.4bn in FY14 (June-ending fiscal year). The company is an end-to-end IT and BPO company, offering services such as software development, maintenance, enterprise application services, infrastructure management services and BPO. HCL offers these services to industry verticals like financial services, manufacturing, retail, hi-tech, life sciences and energy and utilities. HCL, like its peers derives a majority of its revenues from the North American market.
The company has grown its consolidated revenues, EBITDA and net profits at CAGRs of 25.5%, 30.3% and 37.9%, respectively over the period FY09-FY14 and had a total of 91,691 employees on its rolls at the end of June 30, 2014. HCL’s consistent dollar revenue revenue growth (3.4% CQGR over 4QFY12-4QFY14) and strong deal wins ($5bn over the past year, 93% of FY14 revenue) drive confidence in the IT major’s ability to sustain revenue growth in FY15/FY16. The infrastructure management services (IMS) business has led growth, with the segment clocking 7.7% CQGR over the period, and accounting for 66% of incremental revenue. Steady improvement in software service revenue growth is also a positive. HCL’s focus on productivity, operational efficiency and utilisation drove EBITDA margin to all-time highs in FY14, with revenue and profit per employee also at all-time high levels. HCL’s industry high revenue productivity is a key lever for sustenance of margins. With greater scale and industry-high revenue productivity, HCL is well place to maintain margins in the 26%-27% range in FY15/FY16.