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Software: Does IT have a silver lining?

Jun 3, 2008

The result season for the January to March 2008 quarter is on its way to get over. While the overall performance of India Inc. has been fair, there have been negative surprises in sectors like engineering, banking and pharma. However, one sector that stood out on the back of a ‘better-than-expected’ performance during the quarter and full year was ‘software’.

Indian IT: Consolidated performance*
(Rs m) FY07 FY 08 Change
Sales 540,165 680,085 25.9%
Expenditure 395,581 509,877 28.9%
Operating profit (EBDIT) 144,584 170,208 17.7%
Operating profit margin (%) 26.8% 25.0%  
Other income 10,576 18,747 77.3%
Interest 4,685 7,529 60.7%
Depreciation 10,698 13,274 24.1%
Profit before tax 139,777 168,153 20.3%
Tax 15,888 21,567 35.7%
Minority interest 531 368 -30.7%
Equity in earnings of affiliates/share of profit of associate 326 341 4.6%
Profit after tax/(loss) 123,684 146,559 18.5%
Net profit margin (%) 22.9% 21.6%  
* Consolidation of results of Infosys, TCS, Satyam and Wipro

In spite of appreciating rupee (during the fiscal ended March 31, 2008) and deepening capital market crisis in the US, software companies managed to maintain margins at near FY07 levels, although there was a slight negative bias for some of these. The heavyweights – Infosys, TCS, Wipro and Satyam - also managed to rake in decent topline and bottomline growth. Infosys and TCS, the bigger two, grew their sales and profits at YoY rates of 20% and 21% (Infosys) and 22% and 19% (TCS) respectively.

If we consolidate the numbers announced by these companies for the fiscal, the combined sales grew by 26% YoY, duly helped by strong volume growth and improvement in billing rates. On an average, these companies reported billing rate improvement within a range of 2% to 5%. However, while the net profit growth underperformed growth in topline in account of the rupee impact, a strong rise in other income helped pare some of the pressure. Incidentally, Infosys alone contributed 38% to the consolidated other income for the four biggies. The company recorded almost a 90% surge in its other income, made possible by a sharp increase in its interest income on deposits with banks, which increased by almost 250% YoY. As a matter of fact, Infosys reported a cash and bank balance of almost Rs 70 bn (US$ 1.7 bn) at the end of March 2008, which led to the spike in other income as discussed above.

What to expect?
While the quarter’s performance was fair when compared to expectations, the fact that the rupee has actually depreciated against the US dollar in the current quarter (1QFY09) might not fully benefit these companies. This is because the contracts that they had recorded in the pervious quarter were at a rate of around Rs 40 per US dollar.

Anyways, the moot question now is what lies ahead in the technology sector for investors. We believe that the sector has enough steam left which can drive future growth. Although the US economy is slowing down and capital market crisis has and is likely to impact business for these software companies, the fact that they (the companies) are trying to increase exposure to other markets like Europe, Middle East and Asia-Pacific is likely to stand them in good stead going forward.

Some of these companies are also trying to focus on new segment of clients (like mid-size local bank) who are looking to reduce costs through offshoring. Increased share form value added businesses like consulting are also likely to help matters going forward.

On a macro perspective, on the back of economic benefits that it provides, the Indian technology offshoring business is expected to grow whether the US economy grows or slows down. This is because growing pressure on technology budgets is forcing US companies to outsource to low cost destinations like India

As the famous economist David Ricardo once said, “Even if a country could produce everything more efficiently than another country, it would reap gains from specialising in what it was best at producing and trading with other nations.” Wouldn’t this theory be applicable for the US and Indian software sector as well?

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