Realign estimates and target prices; remain selectively positive.
We factor in modest deceleration in volume growth and some pricing pressure on account of increased macro uncertainty and cut our FY2012/13E EPS for all companies. Further lowering of multiples (from peak-cycle to mid-cycle) drives a 10-26% cut in our fair value estimates. Nonetheless, we remain positive longer term and see the recent correction as an opportunity to enter select names. Prefer INFO/TCS among large caps and HEXW/MTCL among the mid-cap names.
Cut estimates to factor in increased macro risk
We lower our FY2013E US$ revenue growth estimates for the Tier-I stocks to 13-17% from 18- 22% earlier and for the Tier-II names to 10-15% from 13-21% earlier. Two key drivers – (1) increased macro
uncertainty to drive a modest deceleration in volume growth and lead to some pricing pressure across all players, and (2) relative growth differential between Tier-I names (TCS/Cognizant leading while Infosys/Wipro lagging) has the potential of driving aggressive (though only in select accounts and not broad-based) pricing actions from the laggards. Lower revenue growth estimates also drive modest reductions in margin estimates – all in, a 5-10% cut in FY2013E EPS estimates for Tier-Is and 3-15% for Tier-IIs.
Lower target multiples as well; relative preferences unchanged
We also lower our target multiples on Tier-I names to 15-19X from 17-21X earlier, and for Tier-II stocks to 7-12X from 8-14X earlier. Our revised target multiples reflect mid-cycle multiples as opposed to the peak-cycle multiples that we were using earlier (please see our recent notes dated August 8, 2011 and August 19, 2011 for a detailed discussion on target multiples and growth cycles). Reduced earnings and multiples lead to a 10-26% cut in our end-FY2013E target prices of various stocks. Our ratings remain the same – BUY on Infosys and TCS, ADD on Wipro, Hexaware, MindTree and Patni, REDUCE on HCLT, Mahindra Satyam, and Tech Mahindra, and SELL on Mphasis and Polaris
Recent correction an opportunity to enter select names from a medium-term perspective
We factor in modest deceleration in volume growth and some pricing pressure on account of increased macro uncertainty and cut our FY2012/13E EPS for all companies. Further lowering of multiples (from peak-cycle to mid-cycle) drives a 10-26% cut in our fair value estimates. Nonetheless, we remain positive longer term and see the recent correction as an opportunity to enter select names. Prefer INFO/TCS among large caps and HEXW/MTCL among the mid-cap names.
Cut estimates to factor in increased macro risk
We lower our FY2013E US$ revenue growth estimates for the Tier-I stocks to 13-17% from 18- 22% earlier and for the Tier-II names to 10-15% from 13-21% earlier. Two key drivers – (1) increased macro
uncertainty to drive a modest deceleration in volume growth and lead to some pricing pressure across all players, and (2) relative growth differential between Tier-I names (TCS/Cognizant leading while Infosys/Wipro lagging) has the potential of driving aggressive (though only in select accounts and not broad-based) pricing actions from the laggards. Lower revenue growth estimates also drive modest reductions in margin estimates – all in, a 5-10% cut in FY2013E EPS estimates for Tier-Is and 3-15% for Tier-IIs.
Lower target multiples as well; relative preferences unchanged
We also lower our target multiples on Tier-I names to 15-19X from 17-21X earlier, and for Tier-II stocks to 7-12X from 8-14X earlier. Our revised target multiples reflect mid-cycle multiples as opposed to the peak-cycle multiples that we were using earlier (please see our recent notes dated August 8, 2011 and August 19, 2011 for a detailed discussion on target multiples and growth cycles). Reduced earnings and multiples lead to a 10-26% cut in our end-FY2013E target prices of various stocks. Our ratings remain the same – BUY on Infosys and TCS, ADD on Wipro, Hexaware, MindTree and Patni, REDUCE on HCLT, Mahindra Satyam, and Tech Mahindra, and SELL on Mphasis and Polaris
Recent correction an opportunity to enter select names from a medium-term perspective
We believe select Indian IT names are approaching levels (we are possibly 10-15% away) where an uncertain macro environment is being extrapolated into a severe, sharp, and permanent loss of earnings growth power of these companies. Business model, and consequently, earnings power of these companies based upon market share gains for IT offshoring remains intact, in our view. Post recent macro developments, we are headed into an uncertain environment and we do not know how FY2013E would pan out – our estimates depict our current view on a highly uncertain 2HFY12E/ FY2013E; there could be downside risks. Nonetheless, the key is to appreciate the risk/reward at current levels – this appears favorable to us. We see the recent correction as an opportunity to BUY into the long-term secular market share gain story for IT offshoring through high-quality names. TCS and Infosys are our top picks. Of course, in the current market scenario where sentiments are broadly negative, it would be foolhardy to call the bottom – this remains a near-term risk to our positive thesis on select names, as discussed above.
