The institutional research firm picks Wipro to finish first, followed by Infosys, as it expects industry dynamics to improve in FY13-14. The Economist, however, doesn’t foresee a good future for the Indian IT industry

Espirito Santo Securities (ESS) believes that the information technology (IT) industry will turn the corner in FY13-14 as clients’ discretionary spending is expected to increase with companies’ enhanced performance. Furthermore, the improved outlook of the United States economy is expected to result in increased order inflow to India. The report said, ‘The three distinct positive comments/observations that came out post the results were: discretionary spending is picking up, FY13-14 is looking better than FY12-13 and almost all companies have increased realisation and reported better-than-expected margins’. This is despite the fact that IT budgets continue to be under pressure and are likely to be slashed. But the argument ESS puts forth is that incremental revenues will pour in from small discretionary spends.
 

To see our analysis on earlier ESS reports, click here.
 

However, we are skeptical of Indian IT industry of doing well because the focus of the re-elected American president is it to increase more American onshore jobs. There is talk of bringing some outsourcing jobs back to American shores and this could hurt the Indian IT industry in general. It is not yet known whether the impact will be felt in FY13-14 and how big it will be, but it will surely arrive. In fact, countries like Philippines and Vietnam already have a cost advantage over India, in terms of wage differentials. The Economist even carried a special section on Indian outsourcing (issue dated 19^th-25^th January) which states that some of the biggest outsourcers, for instance General Electric and General Motors, have already brought back some IT jobs back to American shores. The Indian IT industry has every reason to worry about this trend, especially with president Obama at the helm for another four years. The impact may not be felt in FY13-14, though. One factor that may buoy the industry is the rupee-dollar equation as Indian economy is still weak. But this is an external factor and subject to speculation.
 

One of the biggest beneficiaries has been Wipro, according to ESS, which believes the company to be worth Rs475 per share. Wipro, which has often (perhaps unfairly) been compared to Infosys, has recouped much of the valuation as its realisations have dramatically improved. According to ESS’s report, ‘Wipro’s margins have increased with improvement in realisations and will be sustainable with increased efficiencies. One quarter of strong volume growth will have a magnified impact on margins’. The report further said, ‘Wipro has invested over the past year to differentiate the front-end (sales) and standardise the back-end (delivery). The benefits of these are already visible in the form of improving deal traction and revenue productivity’.
 

ESS believes that HCL Technologies will be one of the Tier-1 IT stocks to look out for because of change in leadership which will happen in July 2013, when Vineet Nayar steps down as CEO. This is a significant event as Nayar has been associated with HCL Technologies since 2005, which is a long time.
 

Furthermore, the report said, ”While the margin expansion has been commendable, we believe HCL Technologies will have to reinvest in the business in light of the increasing competitive intensity in the restructuring market and the company’s expectations of a weakness in discretionary spends”. While HCL Technologies believes that discretionary spending in its portfolio is a concern, we feel that it is also a concern for the industry as a whole. ESS believes that HCL Technologies is worth Rs748 per share.
 

ESS is neutral on Tata Consultancy Services and pegged its value at Rs1,450 per share.