Software: Time for introspection! - 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: Time for introspection!

Dec 6, 2003

In the recent past (one month to be precise), stocks from the Indian software sector have been 'cynosure of speculators' eyes' as seen by their rapid rise beyond fundamentals. However, this might not seem 'out-of-the-world' movement for software stocks that have witnessed moves of greater velocity in the past. In this write-up, we would take a look at the performance of the Indian software sector (chiefly represented by Infosys, Wipro, Satyam) in the recently concluded September quarter, perform a SWOT analysis of the same, and see whether there is actually any reason for these stocks to romp home so fast. First things first, as said earlier, Indian software stocks have moved up rapidly in the past one month. While this has been an extension of the rally that began in April 2003, the upward movement in the month of November has been a highlighter. Take a look at the graphs below.

Despite being part of the overall rally, stocks from the software sector have lagged the Sensex (and they continue to do so!) since the beginning of the year 2003. However, if we consider only the month of November 2003, there emerges a stark contrast. In November, almost all major software stocks have outclassed gains on the Sensex. While there is nothing to deny the fact that Indian software companies have been putting in improved performance in recent times, nothing so dramatic seems to have happened in the past one month that calls for this euphoria on the tech street.

While benefits for Indian companies from improvements in the US economy are yet to flow in substantial numbers (in form of large-size deals), there definitely have been a number of small contracts that Indian companies have garnered as can be seen by increasing utilisation levels and continuing growth on the volumes front. Also, the pressure on billing rates charged by these companies to their clients seems to have subsided now as iterated by managements of most of the domestic software majors.

The consolidated* picture...
(Rs m) 1QFY04 2QFY04 Change
Sales 28,284 30,978 9.5%
Other Income 705 1,125 59.6%
Expenditure 20,689 22,683 9.6%
Operating Profit (EBDIT) 7,595 8,295 9.2%
Operating Profit Margin (%) 26.9% 26.8%
Interest 8 8 0.0%
Depreciation 1,143 1,385 21.2%
Profit before Tax 7,149 8,027 12.3%
Tax 971 1,239 27.6%
Profit after Tax/(Loss) 6,178 6,788 9.9%
Net profit margin (%) 21.8% 21.9%
No. of Shares 612.3 612.3
Diluted Earnings per share* (Rs) 40.4 44.3
(* annualised)
*Companies under consideration are Infosys, Wipro and Satyam

All this and much more has helped these Indian software majors to post 'decent' results in the recently concluded September quarter results. The table above presents a consolidated picture of the financial performance of the three Indian software majors (Infosys, Wipro and Satyam). While these companies have together reported sequential revenue growth of 9.5% for the September quarter, the sequential profit growth has been marginally higher at around 10%. More importantly, these companies have been able to maintain their operating margins at almost the June quarter levels.

Now, all that is what has already happened for the Indian software sector. Considering the past and the present, let us perform a SWOT (strengths, weaknesses, opportunities and threats) analysis for the sector. Consider the chart below.

While strengths and weaknesses of the Indian software sector have been an outcome of the past decisions and initiatives, what lies ahead is well captured in the opportunities and threats. While India's share in the global technology marketplace continues to remain miniscule (at 1.8%), this presents an opportunity for Indian software companies to increase their penetration into newer markets and newer domains. Further, as more global companies are looking towards outsourcing their tasks to Indian software companies with a view of becoming more cost competitive, the imperative for the former (Indian software companies) lies in moving rapidly up the software value chain, into high-end domains like telecom and banking services. In this initiative of moving up the value chain, Indian companies are then likely to benefit from the scale advantages of the selling and marketing expenditure that have been made in the past.

Talking about probable threats to the fortunes of these Indian tech companies, the most serious being the 'successful' replication of the Indian offshoring model by the global tech biggies like EDS, IBM and Accenture. While, at present, most of the managements of Indian software companies are of the belief that it would be rather difficult for these global giants to completely replicate the Indian model owing to the changes that they would have to make in their revenue and cost structures, as and when these MNCs are successful in the replication process, it would pose tough times for the Indian companies.

Another threat arises on account of high levels of attrition rates that come as a part of global competition like this. As the global technology majors plan to ramp up their Indian operations by hiring high-skilled manpower, raising salary levels to retain key employees becomes a necessity for these Indian software companies. And this would necessarily increase pressure on their operating margins that are yet to come out of the jinx of falling billing rates and high SG&A expenses.

Finally, Indian software companies, in retaliation to increasing pressure due to global economic slowdown, have reengineered their business models and widened their service base through moving up the software value chain. Not only have these changes helped these companies in improving their financial performance, even the stock markets have rewarded them as seen by the rally that these stocks have been witnessing since their April 2003 lows. However, there have been several bouts of volatility in between this rally and the rapid rise witnessed in the month of November raises some serious questions regarding the sustainability of this rally.

*Based on our FY04 EPS estimates

A look at the above table makes it clear that valuations (based on our FY04 earnings estimates) for most of the Indian software majors now look stretched. And this is a result of the 'irrational exuberance' displayed by market players on stocks of these companies time and again. The main concern lies in the fact that nothing so 'revolutionary' seems to be happening with thesoftware companies that vouch for their prices rising so rapidly. While the overall environment certainly has shown signs of improvement, investors need to practice utmost caution from rallies of these kinds as they take along with them even those companies that have destroyed capital in the past. Temptations are definitely very hard to suppress but we believe, fallacies resulting from such temptations in the past must have made investors more wise and introspective in their investment decisions.


Equitymaster requests your view! Post a comment on "Software: Time for introspection!". Click here!

  

More Views on News

COFORGE at All Time High; BSE IT Index Up 3.3% (Market Updates)

Sep 25, 2020 | Updated on Sep 25, 2020

COFORGE share price has hit an all time high at Rs 2,287 (up 7.7%). The BSE IT Index is up by 3.3%. Among the top gainers in the BSE IT Index today are COFORGE (up 7.7%) and ORACLE FINANCIAL (up 0.6%). The top losers include L&T TECHONOLOGY (down 0.5%) and ZENSAR TECHNOLOGIES (down 3.5%).

COFORGE Share Price Up by 5%; BSE IT Index Up 2.5% (Market Updates)

Sep 25, 2020 | Updated on Sep 25, 2020

COFORGE share price is trading up by 5% and its current market price is Rs 2,226. The BSE IT is up by 2.5%. The top gainers in the BSE IT Index are COFORGE (up 5.3%) and TATA ELXSI (up 5.3%). The top losers is MPHASIS .

TATA ELXSI Share Price Up by 5%; BSE IT Index Up 2.2% (Market Updates)

Sep 25, 2020 | Updated on Sep 25, 2020

TATA ELXSI share price is trading up by 5% and its current market price is Rs 1,246. The BSE IT is up by 2.2%. The top gainers in the BSE IT Index is TATA ELXSI (up 5.2%).

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.

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...

How Much Money Do You Need to Be a Professional Trader? (Fast Profits Daily)

Sep 17, 2020

In this video I'll answer a question I get asked often: How much capital do I really need to trade the markets for a living? Let's find out...

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 25, 2020 03:28 PM

COMPARE COMPANY

MARKET STATS