We are downgrading our sector recommendation for Indian IT from neutral to underweight as we watch the margin of safety in Indian IT stocks recede. We see three extant islands of optimism being tested in Indian techs in the coming months. Firstly, over 20% growth is achievable in FY13/14 for tier-1 vendors. Secondly, visa issues are unlikely to alter business prospects. Thirdly, valuations of tier-1 techs are not at risk.
We expect the coming months to be a downward inflexion point for trends in all three parameters driving stock prices down, though June quarter results are unlikely to show any material proof points. Indian IT holds little promise of sustainable absolute returns hereon. We are downgrading TCS and Infosys to underperform.
Within the sector TCS credentials remain very strong but the stock needs to contend with high expectations and over-ownership. FY12 hopes for Infosys have moderated but FY13 expectations remain elevated. Internal issues seem sorted but an unfavourable macro is likely to play spoilsport.
While the demand trajectory for the companies is good for now, it has flat-lined after the surge last year, posing risks to street revenue forecasts for future years. Also, our forecast of a rise in US treasury yields to potentially deflationary levels could impact growth prospects.
Newsflow on the visa front continues to be negative across countries with rejection rates in the US currently running at almost 40%, up from 5%, 18 months ago. We see the visa issue altering the business model for Indian techs with an operational as well as commercial impact.
Valuations of tier-1 techs need to contend with lower revenue/EPS Cagr outlook, as well as challenges from business transformation that lie ahead. The risk of a potential IT spending slowdown further raises the spectre of valuation compression. Bullish management commentary is comforting, but perhaps not actionable given the already high street expectations and the history of the sector?s major moves, where company talk remained positive well into the demand flux.
Also, while confidence on near-term demand remains strong across vendors, commentary on FY12 growth achievement has gradually shifted from the confident certainty earlier this year to hopes of a 2H pick-up. As our checks point to moderating growth we see absolute downsides for tech stocks, especially over the short to medium term.
?CLSA