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Software: Infy guidance holds the key
Mar 27, 2008

Software stocks have had a challenging FY08 and appreciating rupee made things worse for them and now they will head to FY09 with US, their main market, almost into a recession. The high multiple which these companies used to command have now come down in line with the multiple of sensex and rightly so because high growth companies get high PE multiple and when there are concerns about whether the high growth in the past will be repeated in future, the market will not be ready to give it a higher multiple. What could change the outlook?

  1. Infosys guidance of April 15th: Infosys will announce its FY08 results on April 15th. More than the annual results, it will be the revenue guidance for FY09, which will impact the stock price and will also set the tone for other Tier I companies and the sector at large. Infosys historically has been very conservative when it comes to guidance and has been able to outperform it but the margin of outperformance of guidance vis--vis actual has come down over the last few quarters.

  2. IT budgets for CY08: Generally, clients in US finalise their IT budgets for the coming year by December of the previous year but in this year, the clients have taken little longer to finalise their IT budgets. We believe this was largely due to uncertainty prevailing in the US economy. The actual IT budgets finalised by the clients are most likely to be available with FY08 results. Many CIOs in US have hinted on a flat IT budgets in CY08 and in some cases, even a decline. If the US does go into a recession, then it will be another negative for the sector.

    In case of an US recession, the scope of improvement in billing rates is limited largely because the Indian IT companies operate at 25% to 30% EBITDA margins, which the clients are well aware of, thus limiting further increments in billing rates. In case of volume growth, the discretionary projects get cut thereby resulting in lower volumes but maintenance volumes do increase, albeit with a lag effect of say 2 to 3 quarters. This, we saw post the dot-com bust when the Indian IT services, BPO and KPO sectors started flourishing.

  3. Currency movement: The movement in currency had caught everyone unawares in CY07 and to the disadvantage of IT companies, a bulk of the appreciation happened in 1QFY08, post which the movement although not stable has not been erratic either. We have earlier stated that it is not the appreciation in currency, which is a problem, but the speed at which the currency appreciates. If the currency appreciates from Rs 44 to a dollar to Rs 39 and then backs to Rs 41 within a period of 12 months, then it becomes very difficult for an export oriented sector to manage the dollar inflows as taking view on the dollar itself becomes difficult. And any further appreciation in currency from the current levels will impact the performance of the sector as a whole.

What is the way out?
We have recommended most of the top Tier IT companies in the last 12 months and they have not been able to deliver the desired results. We now recommend investors to add Infosys and TCS at these levels and to stick only to leaders (Infosys, TCS, Wipro) because when the sector is going through tough times, it is always advisable to stick to the leaders than the smaller mid-sized players as the leaders have the requisite management and execution capabilities to see them through the tough times.

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