Right click: IT's back as an attractive long-term bet

The stocks of India's top five IT companies may have lost the pre-result gains they made and underperformed the broader market in the past two weeks. But at current valuations, they have once again become an attractive long-term bet, analysts say.

Concerns of more appreciation in the rupee and wage costs may crimp profit margins of TCS, Infosys Tech, Wipro, Satyam Computer and HCL Technologies. But given the wide range of their services and brisk demand for outsourcing, they show no indication of operational weakness so far.

Among the big five, the stock price of Infosys suffered the highest loss of 13% since October 11, the day it announced its July-September quarter results. HCL Tech was the second-biggest loser as its shares declined by nearly 8.9% during the two weeks ended October 24. Wipro, the biggest IT exporter in the country, saw the least fall of 1.4%. On the other hand, the Sensex lost half a per cent during this period.

While all the companies have seen an increase in the order flow and employee headcount in the September 2007 quarter, stronger trend in the rupee vis-a-vis the dollar and increasing cost of talent retention are still areas of concern. "Margin pressure will continue. However, if the rupee appreciation is gradual, companies will be able to manage it.

Further, the top five IT firms have integrated plays, which attracts better billing rates," says Angel Broking IT analyst Harit Shah.

IT stocks may underperform over a six-month horizon, given the currency fluctuations, but growth in returns should come back later, Ventura Securities research head Subramaniam Pisupathi says. "Given the current P/E levels and the growth projections of some for these companies, the earnings multiple (P/E) is very similar to the EPS growth forecast.

This means a PEG ratio of one, which is attractive over a long-term period." During the September 2007 quarter, the rising rupee and growing revenue base moderated growth rates of the big five IT companies even as their performances proved that fears of a slowdown were unfounded. At the aggregate level, sales grew 26% and profit rose 21% compared with the year-ago period.

The growth was backed by robust demand and better pricing on some projects and the companies said the outlook continued to be positive with no indication of demand slowdown so far. TCS COO and head of global sales N Chandrasekaran asserts: "The deal flow is very good. We are completely on track for the next six months."

However, growth rates were down sharply compared with the year-ago quarter when the topline grew 46% and the bottomline 47.5% at the aggregate level for the five companies. This can be attributed to the larger revenue and profit base of these companies and also due to stronger rupee eroding their performance. The rupee is trading near its 10-year highs against the dollar.

Among the top five, Wipro reported the highest revenue growth of 35% during the September 2007 quarter. Its share in the aggregate revenues generated by the top five firms also inched up to 26% from 25% a year ago.

The company attributed the improvement in topline to several large deals won during the quarter and the overall growth across all its verticals. The share of TCS increased from 30% to 31%, but that of Infosys dropped by 50 basis points to 22.5%. Satyam and HCL Technologies witnessed a similar drop in their respective shares.

On the net profit front, Satyam clocked the sharpest jump of 28% followed by HCL Tech (rise of 23.3% in profit after tax) and TCS (22.9%) in that order. Wipro's PAT grew at a much slower pace of 17.6% compared to its topline growth due to low-margin nature of its consumer care and lighting business.

Infosys continued to remain the most profitable company among the top five IT exporters. At 31.3%, its operating margin was the highest among its peers. Even though this was far better than 28.7% of the previous quarter, it was still 80 basis points lower than the September 2006 quarter.