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Software stocks: Apply caution! - Views on News from Equitymaster
 
 
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  • Dec 2, 2003

    Software stocks: Apply caution!

    The month of November has been particularly good for the investors in the Indian software sector as seen by strong gains that stocks from this sector have witnessed in this period. Notably, even shunned companies like DSQ Software, Silverline, etc. have seen their stock prices rally substantially and this brings in all the more reasons for investors to apply caution before making their investment decisions. While growth prospects for the Indian software sector have not changed much from the past, it is not particularly difficult to deduce that speculative actions have played their part in this strong rally in Indian software stocks.

    While it is right to say that the performance that Indian software companies, especially the majors, have shown in the second quarter of FY04 goes in line with the improving prospects of the Indian software sector as a whole, the sudden upsurge in stock prices of almost all companies from this sector seems unwarranted. Take a look at the table below. While rapid gains in November have helped Infosys, Wipro and Digital reverse their losses (or reduce them) for the January-October 2003 period, investors in Satyam have seen their gains more than double.

    Rising, but why?
      Jan-Oct Jan-Nov
    Sensex 46.2% 53.8%
    Infosys -1.2% 8.1%
    Wipro -18.1% -1.2%
    Satyam 11.7% 27.0%
    Digital -12.7% 16.0%

    Just as a matter of fact, in the recently concluded September quarter results announcement, most of the Indian software majors have reported 'decent' growth in their topline and bottomline just providing reasons for investors to improve their outlook towards the sector. Also, most of the managements have indicated towards reduced pressure on their performance in times to come.

    The performance in 2QFY04
      Revenues   PAT   OPM
      1QFY04 2QFY04 Change 1QFY04 2QFY04 Change 1QFY04 2QFY04
    Infosys 10,820 11,348 4.9% 2,781 3,002 7.9% 32.2% 33.3%
    Satyam 5,597 5,985 6.9% 1,215 1,476 21.5% 29.0% 27.8%
    Wipro 11,989 13,745 14.6% 2,061 2,302 11.7% 18.0% 18.0%
    Digital 1,350 1,456 7.9% 302 319 5.6% 27.0% 26.3%
    Hughes 765 850 11.1% 152 169 11.2% 26.9% 26.9%
    MphasiS 1,302 1,429 9.8% 195 255 30.8% 13.5% 15.3%
    i-flex 1,623 1,870 15.2% 398 503 26.4% 31.9% 31.4%
    Total 33,446 36,683 9.7% 7,104 8,026 13.0% 25.5% 25.6%

    While the focus on volume led growth continued in the September quarter, some of these companies actually witnessed marginal improvements in the billing rates they charge to their clients. Now, while this does not signify the reversal of pressure on the pricing front, what this means is 'reduced' pressure on these companies in respect of the overall pricing environment. As the scene on the global technology-spending front seems to be improving, the effects are witnessed in form of reduced pressure on billing rates.

    Now, while there has been some stability restored on the pricing front, Indian software companies are continuing to focus on growing their volumes. And there have been some medium to large size deals that have helped these companies on this front. The most notable of these deals were Telstra (Infosys) and Fujitsu (Satyam). Initiatives on the scalability front also continued in the September quarter with Infosys leading the pack with over 2,000 additions to its manpower. As Indian companies move higher on the software value chain, the need to attract and retain employees would be a key factor.

    All said and done, the positive effects of slowdown seems to be acting now in favour of the Indian software majors that have reengineered their business models through widening their service base and moving up the software value chain. This has indeed provided increased levels of optimism to investors in Indian technology stocks. However, as we had mentioned earlier, valuations for most of the Indian software companies now seem stretched and already factor in growth for the next 2-3 years. Investors, thus, need to practice caution and restrict only to quality companies (like Infosys) with highly scalable business models.

     

     

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