Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Software: Preview 2QFY06 - Views on News from Equitymaster
  • E-MAIL
  • A  A  A
  • Oct 6, 2005

    Software: Preview 2QFY06

    Markets are truly in the stratospheric territory. Abundant liquidity, not just by the 'usual suspects', the Foreign Institutional Investors (FIIs), but also by domestic mutual funds (MFs) has pushed the indices up into totally uncharted waters. At levels of over 8,700, the indices now trade at a price to earnings multiple of around 18 times trailing 12-months earnings, certainly not 'cheap' by any standards. The extent of the rally can be gauged by the fact that the Sensex had crossed the 7,000-mark on June 20. Since then, in about three-and-a-half months, it has gained nearly 25%!

    India Inc.'s 2QFY06 results are slated to begin next week. This is expected to determine the short-term trend of the indices in general. As always, it is the software companies that will be first off the block to announce their results. This time around, as many as three companies will announce their results on the same day - October 11 - Infosys, MphasiS and TCS.

    Software stocks have gained significant ground since 1QFY06. Infosys, TCS and Satyam have gained over 20% each since their lows in July, while Wipro has gained about 16%. However, it must be mentioned that liquidity has been the major driver of this surge in share prices. Fundamentals have not changed that much to warrant such a steep rise in valuations. At current levels, a number of these stocks are more-than-fully valued and the scope for any further upside is very limited in our view, while the downside risk is much higher. Clearly, there is ample room for disappointment and one must practice utmost caution at these levels.

    It has been quite a start to the earnings season this time around, with Geometric Software giving a profit warning for the second successive quarter. Not surprisingly, the stock has crashed since then. But the top tier companies have remained strong. The announcement of big deals, such as the ABN Amro outsourcing contract, by Infosys and TCS has further enthused participants and improved revenue visibility for these companies over the medium to long term.

    Major drivers in 2QFY06
    We attempt to analyse a few major operating metrics that are likely to influence the 2QFY06 results of the software companies.

    Volumes: Once again, as has been the case in the recent past, it is volume growth that is expected to be the major driver of revenue growth. Initial concerns about a slowdown in the key US market and political pressures against offshoring have proved to be short-lived and offshoring is well and truly becoming more mainstream for global corporations. The ABN Amro deal is ample proof of this fact, which saw both Infosys and TCS recording their largest-ever order wins.

    Billing rates: As has been the case recently, the billing rate environment appears to be largely stable. Managements in conference calls with us have mentioned that the major growth drivers for revenues, as mentioned above, will be volumes, rather than billing rate increases. The increases are coming at the newer clients' end. However, since new clients' business does not contribute even 10% of the top tier companies' revenues, this increase will not have any significant impact on the topline.

    It should be mentioned that although companies are not facing any significant downward pressures on their billing rates, getting increases is not proving to be easy either, rather a challenge. Going forward, if cost pressures become acute, then companies may have to push harder for increases. Again, the major driver for an increase in average billing rates will remain an improving business mix in favour of higher-end business like consulting and systems integration.

    Exchange rates and margins: Once again, the rupee-dollar exchange rate will also play a role in determining margins of software companies. This time around, there has been a pleasant surprise on this front. The rupee has actually depreciated against the dollar, euro and pound sterling. Therefore, there does exist a margin upside to that extent. The rupee has lost as much as 1% against the dollar this quarter, while losing in equal measure against the euro. The movement against the pound sterling was largely flat, with a slight depreciation witnessed.

    This assumes significance in light of the fact that in 1QFY06, margins were adversely impacted by the appreciation of the rupee against the euro and pound. This time around, however, the rupee has lost the maximum against the dollar, the major billing currency of the software companies. This might have a positive impact on margins.

    Major levers of margin expansion this quarter are expected to be rupee depreciation against the major currencies, salary hikes already factored in, higher utilisation rates, increasing shift to offshore from onsite and cost efficiencies.

    What to expect?
    While we have outlined our expectations on the major operating metrics that are expected to affect software companies during 2QFY06, we are of the belief that, as an investor, one must take a long-term view of any business, including software. Given the strong momentum expected in offshoring and the fact that Europe, traditionally conservative and a late adopter of outsourcing, has also started to increasingly adopt it, prospects appear bright. This has been adequately proved by the ABN Amro deal. The fact that a leading financial services company has so comprehensively resorted to offshoring would encourage other large companies in Europe to do the same.

    On an overall basis, we continue to remain positive on the sector's prospects. The winning of US$ 100 m-plus deals is expected to intensify and scalability is of critical importance, more now than ever before. Investors can surely look forward to exciting times ahead!



    Equitymaster requests your view! Post a comment on "Software: Preview 2QFY06". Click here!


    More Views on News

    Tech Mahindra: Our Revised View (Quarterly Results Update - Detailed)

    Aug 2, 2017

    A better than expected turnaround in performance results in a change in view.

    Wipro: A Decent Start to the Year (Quarterly Results Update - Detailed)

    Jul 27, 2017

    Digital services drive growth for Wipro in 1QFY18.

    Infosys: A Decent Start to FY18 (Quarterly Results Update - Detailed)

    Jul 14, 2017

    Infosys starts FY18 on an encouraging note with a stable performance.

    Ankit Shah's First Five Insider Recommendations (The 5 Minute Wrapup)

    Aug 5, 2017

    How to get exclusive insider recommendations from Ankit Shah.

    TCS: Currency Volatility Plays Spoilsport (Quarterly Results Update - Detailed)

    Jul 14, 2017

    TCS starts FY18 decently despite an adverse currency impact.

    More Views on News

    Most Popular

    Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

    Aug 7, 2017

    The data tells us quite a different story from the one the government is trying to project.

    Proxy Plays: A Smart Way to Bet on 'Off Limits' Companies(The 5 Minute Wrapup)

    Aug 4, 2017

    The small-cap space is full of small players that are clear proxies to great growth stories and Indian megatrends.

    Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

    Aug 8, 2017

    Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

    Aug 7, 2017

    Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms

    S&P BSE IT

    Aug 17, 2017 (Close)