The domestic and global economic scenario coupled with recent corporate governance issues has made most brokerages revise their call on the software sector.
The recent numbers of the top three IT majors, Infosys Technologies, TCS and Wipro, clearly show that the growth is under pressure with billing rates likely to fall further in the coming months. Market participants expect volume growth to be in mid-single digits and billing rates to decline by three to five per cent in the current financial year.
In a recent report on the technology sector, Asit C Mehta Investment Interrmediates has reduced its price target on Wipro, TCS and Infosys primarily due to margin pressure. The brokerage expects the net profit to decline year-on-year basis. “For the top three companies, we expect volume growth to be in the mid-single digits and billing rates to decline by three to five percent in FY10,” says the report.
It is also assumed an increase in the tax rate of 3-4% in FY10. Hence, it is expected net profits for TCS and Wipro to decline (Y-o-Y) in FY10. Infosys is expected to register a modest growth in net profits in FY10, on account of its ability to efficiently manage its costs.
The report also highlights the point that Infosys and Wipro have guided de-growth in revenues in Q4 FY09 (in constant currency terms) due to the challenging demand environment.
Meanwhile, according to the report, the top three IT companies registered a growth in volume of approximately 2% in Q3 FY09. However, due to cross-currency headwinds, both Infosys and Wipro missed their guidance in dollar terms. In spite of the billing pressure in Q3FY09, Infosys and TCS were able to improve their operating margins on account of the benefit from the rupee depreciating against the dollar explains a report.
According to the brokerage, the focus of management for the next twelve months will be on improving operational efficiency and managing costs. The main margin levers at companies’ disposal are: an increase in offshore revenue mix, and the variable component of salaries.
Interestingly, according to the report, while companies had expected a rebound in revenue momentum in the first half of 2009, currently companies expect only a meaningful uptake in demand to take place only after twelve months, as the economic scenario is unlikely to improve before the fourth quarter of 2009.
The domestic brokerages expects Indian software industry, which registered a growth of 34% CAGR in IT exports over the period of FY2000 to FY2008, to register a mid-single digit growth rate in revenues in FY10 on account of the cut in global IT budget.
Tier I Indian IT companies are expected to outperform the industry in FY10, considering the trend of vendor consolidation by the clients, ability of tier I companies to provide the whole basket of IT services and their relative financial stability which reduces risk perception of the clients.
Besides slowdown in revenues, Indian IT companies are likely to face margins pressure, as clients are likely to push for cut in billing rates. The cut in billing rates are likely to be compensated to an extent by lower wage hike and reduction in variable component of employees cost.
The tax rates are likely to increase, as tax exemption available under STPI scheme ceases on completion of 10 years from the inception of unit in STPI or post FY10 which ever is earlier.
Another aspect the last but not the least is that the incoming volume of work in the IT sector to large IT companies in India will be significantly less which ay consequently affect Billing. However, small and medium IT enterprises may have a status quo as far as inflow of work is concerned and even in some cases it can increase.