Demand outlook bright, say IT analysts

One weak result by the bellwether, but two strong showings – so on balance, the IT outlook scale is tipping on the optimistic side. Despite the troubled start to the earnings season with Infosys' below par performance, TCS and HCL Tech have topped analyst expectations and eased tech outsourcing concerns.

Most analysts tracking the sector see a strong demand environment next fiscal, given the global momentum in business purchases of technology products and services. But they are also quick to caution about the margin issues, due to currency headwinds and wage pressures ahead.

A look at the latest performance of the three large Indian vendors, TCS, Infosys and HCL Technologies combined (Wipro results are on April 27) shows an average revenue growth of over 28 per cent year-on-year and 4.5 per cent sequentially, for the traditionally soft March quarter. The average net profit growth, on a similar scale, comes to over 26 per cent year-on-year and about 10 per cent sequentially.

Headroom for growth

“The results reflect the continued attractiveness of offshore outsourcing services. There is demand and compelling value proposition around arbitrage, which will not go away in the medium to long term,” says Mr Vikash Jain, Partner at advisory firm Everest.

Moreover, since technology adoption has not percolated to every vertical and market, there is also significant headroom for growth, he adds.

Mr Sanjeev Hota, a senior research analyst at Mumbai-based brokerage Sharekhan does not see any ‘structural problem' with the sector. “The demand for technology is strong and that is also underlined by the performance of global IT firms like Accenture and Oracle,” he says.

He expects the top IT companies to deliver a blended sales growth of about 25 per cent for fiscal 2012. Mr Hota considers Infosys' performance as “an aberration” in the tech pack, and ascribes its pain point on the volume front (a 1.4 per cent volume decline in March quarter) to client specific issues. “They may be foregoing some volume growth because it is not matching margin expectation,” he believes.

By contrast, HCL Tech has delivered 4.8 per cent volume growth while TCS posted 2.9 per cent growth (it topped Infosys but trailed street estimates).

Demand Optimism

The optimistic tone on demand scenario resonates with TCS' recent management commentary. Its Managing Director and CEO, Mr N. Chandrasekaran, says the company is “chasing more deals this time” than it was a year ago. Moreover, the company's customers, in a recent poll, indicated higher IT spends this year.

As it is, Forrester has raised the forecast for the US tech market growth for 2011 to eight per cent from 7.4 per cent estimated initially. According to Forrester, enterprise purchases will grow faster than small and medium-size business buying, and manufacturers and utilities will outpace government, retail, media and leisure.

Wage and currency

That said, factors like wage hikes and currency movement will continue to pose a risk to profit margins of Indian vendors. TCS and Infosys will dole out offshore wage hike of 12-14 per cent and 10-12 per cent, respectively, while HCL will announce pay increases closer to September quarter.

“Our approach will be different for different set of players. For Infosys and TCS - which have traditionally played on higher margins - the priority will have to be aboutmaintaining the margins, while in the case of HCL and Wipro, the street will want to see a margin expansion,” says a Mumbai-based analyst.

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