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Cherry picking: Why it is a good time to invest in IT stocks

Last updated on: July 15, 2013 17:52 IST

Cherry picking: Why it is a good time to invest in IT stocks

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Devangshu Datta in New Delhi

Smaller IT companies could well ride the same trend of strong dollar and grow faster as well.

The towering reputation of N R Narayana Murthy (NRNM) is being cited as one reason for the stock market regaining faith in Infosys. 

The stock has a habit of making massive swings on the day of announcing its quarterly results. The last few quarters had seen disappointing results and the stock had been hit hard.  It fell by 20 per cent in a single session when results were declared in April. 

Bringing back NRNM from retirement seems to have put heart back in the stock. Even so, there were reports that FIIs had pared their holdings down before the April-June (Q1, 2013-14) results were announced on Friday. In the event, the stock bounced 11 per cent in that session.

The results and guidance were good, but not extraordinary. In rupee terms, revenues were up 17 per cent compared to Q1, 2012-13, and about 7 per cent from Q4, 2012-13. 

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Photographs: Courtesy, TCS
Tags: NRNM

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However, profits were slightly lower than in Q4, 2012-13. This is partly because Infy has hiked wages, in a quarter of heavy churn - over 9000 employees left, while around 10,000 were hired. Employee utilisation was up.

Revenue remains US dependent with roughly 67 per cent coming from North America and about 22 per cent from Europe. 

In US dollar terms, revenue rose by about 2.7 per cent compared to Q4, 2012-13. The guidance for 2013-14 remained unchanged with sales growth expected to be between 6-10 per cent in Dollar terms.

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Image: Infosys' pyramid-shaped building in Bangalore.
Photographs: Courtesy, Infosys

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Consider these numbers in the light of dollar appreciation. Between April-June, the dollar rose by about 10 per cent versus the rupee. That implies revenue growth wasn't particularly good. EPS growth was single digit and operating margins remained flat.

The consulting business contributed about 33 per cent to revenues, up from about 31 per cent. It also inflated costs because it requires discretionary spending. Infy appears committed to growing the consultancy business. 

This may be a drag for a while and also consultancy is liable to be more unpredictable in terms of revenue stability.

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Image: Women stand next to a shop selling garlands made of Indian currency notes.
Photographs: Mukesh Gupta/Reuters
Tags: EPS , EPS

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One may safely assume that, given further rupee depreciation, Infy will deliver decent full-year results if it meets the guidance.

However, almost certainly, other IT businesses will beat Infy over this quarter and probably, over the full-year in terms of growth.

This means HCL Tech (which is trading close to new 52-week highs) and TCS will probably outperform in terms of appreciation. Smaller IT companies could well ride the same trend of strong dollar and grow faster as well.

In terms of industry correlations, the performance of the CNX IT index would suggest that the industry has been a great hedge. This is no surprise because of the rupee's weak performance. 

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Image: Employees at TCS office.
Photographs: Reuters.

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The 20-stock index is up about 20 per cent in the past year - it has done much better than the Nifty's 12.5 per cent. Naturally, given global and local trends, investors would be looking at overweight allocations to the sector.

Infy has the highest weight (almost 48 percent) in the index, but it's somewhere in the middle of the pack in terms of share performance. 

Infy (up 13.5 per cent YoY) has been beaten by seven companies including HCL Tech, CMC, TCS, TechM, Vakrangee, MindTree and Eclerx. 

As many as eight of those 20 companies have delivered negative share performances with Educomp (-78 per cent) and Core Education (-90 per cent) among the worst. Naukri, Hexaware, Rolta and Polaris are also under-performers.

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Photographs: Punit Paranjpe/Reuters

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Clearly, the investor is likely to do better if her can pick and choose the right stocks, rather than blindly buying every IT stock for broad sectoral exposure. This sort of decision gets tricky.

The other thing to be noted is that the IT services industry is also going through a transitional phase.

The widespread adoption of the cloud and of cloud-based applications has reduced the effectiveness of the pure headcount model of services. 

IT services is no longer only about providing x number of manhours. For that matter, many nations (not just the US) have been contemplating higher levels of protectionism and that could work against the outsourcing model.

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Photographs: Arko Datta/Reuters
Tags: US , US

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Companies have been looking for ways to move on, but there are no guarantees that all of them will be successful.

HCL has moved into infrastructure for instance, while Infy is looking at consultancy and other things in its 3.0 strategy. One of NRNM's tasks will be to modify that strategy to fit with a changing environment.

Despite all the if and buts, the most cogent short-term reason to be overweight in the sector must be the weak rupee.

Given India's macro-economic problems, that will continue to make IT services more competitive and also inflate profits for any dollar-earner.


Image: Rupee notes.
Photographs: Reuters

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