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Software Industry – Fundamentally strong - Views on News from Equitymaster
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  • May 29, 2000

    Software Industry – Fundamentally strong

    Indian software companies are fundamentally strong with improved financial performance, strong cash flow and increasing value added services. In the past 3 months, stock prices of software companies have come down by more than 60%. This is due to the fact that investors’ confidence in the sector is shaken. However the fundamental case for investing in the sector is still intact.

    Excellent financial performance
    In the past 12 months financial performance of the software companies improved considerably. The Y2K related work gave the software service industry strong cash flow, critical size and a satisfied customer base. The companies in the sector have become stronger to take on large projects on a variety of technology platforms. Software companies have transformed themselves from providing low value added services like coding and maintenance to high margin business of system design, IT consulting and business consulting. The cost-effectiveness and competitiveness coupled with the focus in new business areas like e-business is expected to accelerate the growth of the companies further. The low cost ensures that Indian companies are often better prepared for the e-commerce boom than their counterparts elsewhere in the world.

    The sector is financially in a good shape with operating margins of more than 30% and excellent revenue growth. The financial strength of the companies has translated into building of technical and project management skills. More significantly, the quality of growth of sector major was even better.

    Comparative financials
    Particulars NIIT Infosys Satyam Hughes Software HCL Technologies
    Sales growth 27.0% 73.0% 79.0% 57.0% 40.0%
    Net profit growth 32.0% 117.0% 79.0% 157.0% 94.0%
    Operating profit margins 34.0% 39.0% 37.0% 38.0% 15.0%
    Net profit margins 24.0% 32.0% 19.0% 28.0% 11.0%

    The valuations of the software companies are likely to improve as consolidation takes place in the sector. Companies with huge cash flows will be placed at an advantage as the government has recently clarified the norms for foreign acquisition. The strong underlying earnings growth coupled with cutting edge of technology in terms of services is expected to bring re-rating in the valuations.

    Comparative valuations
    Particulars NIIT Infosys Satyam Hughes Software HCL Technologies
    Market Price (Rs) 1,600 5,990 2,182 2,145 965
    P/E (x) 43 149 78 94 127
    Market Cap/Sales (x) 11 39 15 33 7



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