Software: Look further ahead! - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Software: Look further ahead!

Apr 26, 2005

Performance summary
The recently concluded fourth quarter of FY05 saw Indian software majors reporting a slower (relative to previous quarter) sequential growth in the topline and a dip in bottomline, much due to lacklustre performance from TCS and the appreciation in the value of rupee vis-a-vis the US dollar. The effect was also seen on the operating margins front. In this write up, we analyse the performance of the sector (through consolidation of results of the four majors) and see what investors in software stocks can expect going forward.

Indian IT: 4QFY05 performance...
(Rs m) 3QFY04 4QFY05 Change FY04 FY05 Change
Net sales 74,652 78,445 5.1% 203,762 285,383 40.1%
Other income 1,797 574 -68.1% 4,289 3,862 -10.0%
Expenditure 53,504 57,221 6.9% 150,097 205,942 37.2%
Operating profit (EBDITA) 21,148 21,224 0.4% 53,665 79,441 48.0%
Operating profit margin (%) 28.3% 27.1%   26.3% 27.8%  
Depreciation 1,677 2,013 20.0% 5,471 6,458 18.0%
Profit before tax 21,242 19,776 -6.9% 52,437 76,780 46.4%
Tax 3,228 2,687 -16.8% 7,918 11,247 42.0%
Profit after tax/(loss) 17,983 16,676 -7.3% 44,254 62,839 42.0%
Net profit margin (%) 24.1% 21.3%   21.7% 22.0%  
* Consolidated to include results of Infosys, Wipro, Satyam and TCS

About the sector
For Indian software companies, the past two years have marked a shift in demand from low-end services to high-end ones, like IT consulting, package implementation and systems integration. Now, while Indian software companies are increasingly facing competition from global MNCs who are replicating the Indian offshoring model, the need of the hour is to rapidly move up the software value chain.

Increasingly, the demand for technology is likely to be more guided by the 'Return on Investment' factor, i.e., how much of cost saving or return on investment can be obtained by clients from their IT spending when quality execution capabilities is a given attribute. As such, large Indian IT companies that have provide a broad range of services and have proven capabilities in executing large and complex projects are likely to emerge winners. However, to maintain strong growth in the long-term, scalability and quality offerings would be the key.

What has driven performance in 4QFY05?
Positive bias for billing rate continues:  The fourth quarter witnessed the positive bias for billing rates continue as these IT companies increasingly saw higher than average billing rates from their existing and new clients. The strongest growth in rates came for Infosys, which saw its onsite and offshore rates jump sequentially by around 1% each. On the other hand, while there was a slight improvement in offshore rates for Wipro, their onsite rates declined by around 3% QoQ. Overall, while the change in billing rates has not been significant enough to make a major effect on the topline, volumes have continued to lead the growth in the same (the topline). For instance, offshore and onsite volumes for Infosys grew QoQ by 5% and 7% respectively. However, the growth in volumes for all the companies was relatively lower than what was seen in the previous quarters. Particularly, the managements of Infosys and TCS have indicated that certain client specific issues have led to this marginal slowdown in offshoring volumes in the fourth quarter, something that might have an impact on performance in 1QFY06 as well. 4QFY05 also saw companies report higher utilisation levels, which were possible fallout of a lower rate of hiring in the quarter.

Margins under pressure from rupee appreciation:  While Infosys reported a margin expansion in the quarter and Satyam reported flat margins, those for Wipro and TCS contracted. However, if one were to consider margins for the full year, all the four companies have reported improvement in the same. Increased proportion of revenues coming from offshore services, higher utilisation levels and leverage on the SG&A front have been the key factors aiding margin expansion in FY05. We believe that these factors will continue to help these companies report muted declines in margins going forward. However, uncertainty on account of rupee-dollar movement will also have an impact on the margins. As a matter of fact, every 1% appreciation in the value of rupee negatively affects operating margins by 30 basis points (this is assuming that, on an average, 30% of costs are in rupee terms).

TCS casts pressure on the bottomline:  The graph below clearly indicates the kind of pressure exerted by TCS on the net profit growth of the consolidated entities during the quarter. The company, on account of poor operating performance and some extraordinary expenses during the quarter, reported a 34% sequential decline in net profits. If one were to remove the TCS figures and consolidates only for the other three companies, the sequential net profit growth stands at 10%, from a negative of 7.3% as shown in the table above.

What to expect?
As per our calculations, the average P/E of these four companies under consideration is around 17.8 times expected EPS for FY07. This seems pretty attractive from a long-term basis. As mentioned above, while some managements have indicated of a sedate growth in 1QFY06, investors should not base their decision on the expected performance of just one quarter. Looking further ahead, we expect these software services majors to continue on the path of a strong growth as the improvement in Indian offshoring story strengthens.

However, there is a risk to our assumptions. For the sector as a whole, the movement on the currency front is likely to be a strong factor that could affect profitability in the coming quarters. As seen in recent times, led by pressures of a huge current account deficit, the US dollar has resumed its depreciation against the Indian rupee and other major global currencies. If this were to continue in the future, and that the rupee were to strengthen further, profitability of these companies would be impacted.


Equitymaster requests your view! Post a comment on "Software: Look further ahead!". Click here!

  

More Views on News

PERSISTENT SYSTEMS at All Time High; BSE IT Index Up 0.4% (Market Updates)

Sep 28, 2020 | Updated on Sep 28, 2020

PERSISTENT SYSTEMS share price has hit an all time high at Rs 1,324 (up 4.3%). The BSE IT Index is up by 0.4%. Among the top gainers in the BSE IT Index today are PERSISTENT SYSTEMS (up 4.3%) and ORACLE FINANCIAL (up 1.7%). The top losers include INFOSYS and TCS (down 0.1%).

TAKE SOLUTIONS Share Price Up by 10%; BSE IT Index Up 0.7% (Market Updates)

Sep 28, 2020 | Updated on Sep 28, 2020

TAKE SOLUTIONS share price is trading up by 10% and its current market price is Rs 50. The BSE IT is up by 0.7%. The top gainers in the BSE IT Index is TAKE SOLUTIONS (up 10.0%).

MPHASIS Share Price Up by 5%; BSE IT Index Down 0.2% (Market Updates)

Sep 28, 2020 | Updated on Sep 28, 2020

MPHASIS share price is trading up by 5% and its current market price is Rs 1,339. The BSE IT is down by 0.2%. The top gainers in the BSE IT Index are MPHASIS (up 5.3%) and TAKE SOLUTIONS (up 6.7%). The top losers are WIPRO (down 0.3%) and TCS (down 0.8%).

PERSISTENT SYSTEMS at All Time High; BSE IT Index Down 0.2% (Market Updates)

Sep 28, 2020 | Updated on Sep 28, 2020

PERSISTENT SYSTEMS share price has hit an all time high at Rs 1,250 (up 1.5%). The BSE IT Index is down by 0.2%. Among the top gainers in the BSE IT Index today are PERSISTENT SYSTEMS (up 1.5%) and ORACLE FINANCIAL (up 0.8%). The top losers include INFOSYS (down 0.3%) and TCS (down 1.2%).

More Views on News

Most Popular

Why We Picked This Small-cap Stock for Our Hidden Treasure Subscribers (Profit Hunter)

Sep 17, 2020

This leading household brand will profit big time in a post covid world.

My Top Stock to Buy in this Market Selloff (Profit Hunter)

Sep 22, 2020

The recent correction offers a great opportunity to buy this high conviction smallcap stock.

Can the Nifty Fall to 10,200? (Fast Profits Daily)

Sep 24, 2020

The Nifty has reached an important support level today. If it breaks then we could see further downside.

What Do the Charts Say About Buying Smallcaps Now? (Fast Profits Daily)

Sep 18, 2020

Everyone seems to be excited about buying smallcaps now...but is it the right thing to do? What do the charts tell us? Find out in this video...

More

Covid-19 Proof
Multibagger Stocks

Covid19 Proof Multibaggers
Get this special report, authored by Equitymaster's top analysts now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE IT


Sep 28, 2020 (Close)

S&P BSE IT 5-YR ANALYSIS

COMPARE COMPANY

MARKET STATS