The past three quarters have seen improvement in macro demand indicators: (i) improvement in client financials in banking and financial services (especially in US banks, even as European banks remain weak), Manufacturing (across subsectors such as Hi-tech, Auto & Chemicals) and Oil & Gas; (ii) improvement in confidence indicators (CEO and Consumer); and (iii) improvement in US Services and Manufacturing PMI. However, sustainability of uptick is suspect, in our view, as (i) the uptick in growth in Telecom might not be sustainable; (ii) Healthcare demand could soften further as client revenue growth slows and uncertainty around Obamacare continues; and (iii) Retail/Consumer segments could stay weak given sluggish client financials.
Valuations at near five-year average/~8% discount to Sensex
Tier 1 IT trades at 16.6 1year fwd EPS, in line with its five-year average on our estimates and a 7% discount to Sensex on consensus estimates. Also, IT trades at near historical discounts to other defensive sectors (FMCG).
Remain cautious & selective: HCLT only Buy, prefer CTSH in Neutrals
While there has been an improvement in macro demand indicators, we are not convinced on any material growth revival, as: (i) near-term improvement could be more seasonal and less sustainable; (ii) recovery has been uneven, with US BFS, Energy & Manufacturing recovering but Europe BFS, Healthcare, Retail and Telecom showing indications of slower growth; and (iii) competitive dynamics and uncertainty on immigration could impact near-term demand. Our cautious stance on the sector is driven by: (i) weak exit growth in FY17 or possible slow start to FY18F; (ii) structural drags from slower-growing large legacy business exposure; and (iii) external risks (immigration/uncertainty in US Healthcare/BFSI regulations). We look for Tier 1 IT (ex Cognizant Technology Solutions ) USD revenue/EPS CAGR of 7/3% over FY17-19F. Hence, we remain selective.