Kotak Securities has come out with its report on IT sector. The research firm is cautious on IT sector as FY2014E performance is uncertain even as the Street is building in a recovery; what is certain is a weak 2HFY13.
Better late than never- Nasscom cuts FY2013E exports guidance. Nasscom has cut Indian IT industry exports guidance to 9-12% growth, down from 11-14% given out in Feb 2012. The 3% range of the guidance has not changed even after taking stock of 1HFY13 performance. Revised guidance at the upper end appears aggressive even now. Tier-1 IT collectively may grow barely in line with the industry, a step-down from historical market share gain. Retain Cautious stance; FY2014E performance is uncertain even as the Street is building in a recovery; what is certain is a weak 2HFY13.
A timely correction in industry growth guidance to 9-12%- Nasscom expects Indian IT and BPO exports to grow to USD 75-77 bn in FY2013E from US$69 bn in FY2012, implying a growth of 9-12%. This is a step-down from 11-14% guidance given out in Feb 2012. While the upper end of the guidance at 12% is still aggressive, revision is timely and takes into consideration a slow start to the year on contracting and muted spending in financial services and telecom verticals. The wide band of guidance even after taking stock of 1HFY13 performance is surprising and perhaps captures wider uncertainties in the market for IT services.
Pace of share gain for Tier-1 IT to slow down- Tier-1 IT as a pack may, at best, grow in line with the industry growth rate. This is a departure from historical trend of share gain for Tier-1 IT. Note that the Tier-1 IT pack (Infosys, Wipro, TCS, Cognizant and HCLT) has outperformed the industry CAGR by 4.7% over the past five years. Possible reasons for the change, in our view, could be (1) share of the Top-5 players is high and has increased to 46.8% of industry export revenues from 38.5% five years back, (2) acquisitions have been partly responsible for the increase in share for the top-tier players and (3) fragmentation in the IT services driven by enhanced list of competitive players, smarter sourcing strategies of clients and focused approach of relatively smaller players. Tier-1 IT companies have grown 10.9% in 1HFY13.
FY2014E may decide stock performance but don't lose sight of weak 2HFY13- Change in IT budgets and timely completion of budgeting cycle will be critical for growth prospects of IT companies for FY2014E. Initial comments of Tier-1 companies indicate some progress and hope of improvement in spending. Street has already assumed some improvement with average consensus growth forecast of 13% for Tier-1 IT in FY2014E (up from 11% growth in FY2013E). While discussions on FY2014E will continue over the next three months, what cannot be disputed is that (1) IT companies get into seasonally weak 2H and (2) 2HFY13 will be weaker than usual due to extended shutdowns and no year-end 'budget flush'.
Fragmentation is worrying, recovery in IT spending critical for industry health- Consolidation has been the underlying reason for investment in the Tier-1 IT. However, FY2013E could be the first year when Tier-1 IT would barely grow in line with Nasscom's industry revenue growth guidance. This once again emphasizes the fragmentation in the market. A list of 3-4 players in the Tier-1 category three years back has now expanded to 7-8 players. At the same time, industry growth has tapered off. The industry as a result is not in equilibrium. Irrational behavior of an underperforming player can disrupt equilibrium and put pressure on pricing and profitability. Only solution to stall predatory behavior is uptick in global IT spending that can ease the pressure and allow players to achieve growth aspirations. It is still too early to take a call on FY21014E though Street estimates already build in improvement. Stay underweight in the interim.
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