IT stocks may fall further

Written by fe Bureau | Updated: Sep 28 2011, 05:47am hrs
Indian IT stocks have recovered from their recent lows on beneficial forex (rupee-dollar rate) movements. However, we see this as a risky, short-term trade as the assumption behind it is that currency rates will be sustained at current levels. Should they reverse course, investor be faced with a double-whammy of weakening demand and adverse FX.

Ahead of Accentures Q4FY11 results this week, we advice investors to be careful in drawing implications for Indian IT. While IT services are in general a late-cycle play, historical evidence suggests that companies such as Accenture that operate on longer-term contracts to retain demand longer than Indian peers in a recessionary environment.

Our thesis continues to be hinged on belief that the current environment is not supportive of the 4-5% qoq average revenue growth that consensus is building until FY13. We foresee at least two muted quarters in this period and expect further street EPS cuts, which combined with continued risk aversion, should take stock prices down over the next few months. On a relative basis, we continue to prefer TCS.

For investors who disagree with our assumptions, we have constructed four EPS and stock price scenarios. Of these, the two likeliest scenarios to us are our base case and another that assumes more lenient investor risk aversion (suggests stocks are close to being fairly priced). We expect stocks to trade between these risk-on and risk-off term, but eventually trend down to our base-case targets.

Finally, from our recent meetings in Asia, it appears investors are underweight on Indian IT and some questioned if this could prevent more downside for stocks. However, as per data as of June 2011, the extent of the underweight is similar to what it has been for the several quarters now. So, unless the tilt has changed considerably since June, we see stocks are far from being oversold.

BNP Paribas