Software stocks expected to show some improvement in Q2
Moneylife Digital Team 05 October 2012

Demand is likely to improve in the IT Services sector in the second quarter. Market trends include cost efficiency drive at clients and slow incremental business with market share shifts, says Nomura Equity Research 

Nomura Equity Research in its Quick Note predicts improvement in growth trajectory over the period second to fourth quarters of FY12-13 in the IT services sector in India. Aggregate revenue growth of 3.7% quarter-on-quarter (q-o-q) for the IT services sector in the second quarter is expected, which is better than the growth of 1.7% q-o-q in first quarter, in line with seasonality. However, some problems like discretionary demand continuing to be soft, and large revenue contributors like BFSI (banking, financial services and insurance sector) and telecom continuing to be sluggish, are likely to remain in the current financial year, according to Nomura.
In Nomura’s view, the following trends are anticipated in the IT services sector:
 Cost efficiency drive at clients leading to improved demand for IT companies.
 Slow incremental business with market share shifts playing a more important role in  
   demand generation.
 Equities likely to benefit would be those which have market share gain-focused
    players with lower margin thresholds and Tier 2 players making a bigger delta on
    their smaller revenue bases. 
 Companies with current business momentum are likely to do well.
 It is too early to play hopes of a revival in turnaround candidates, namely Infosys
    and Wipro. 
 HCL Technologies, followed by Cognizant, remain the top buys in Tier-1 IT, Hexaware
    and iGATE remain the top Buys in the Tier-2 IT in the stock market
 Preference towards TCS (Tata Consultancy Services) over Infosys and Wipro within
   the neutrals in the stock market. 
•  Infosys remains the least preferred stock in Tier-1 IT.
•  Margin pressure from recent rupee appreciation especially for companies which
    haven’t gained materially on margins from rupee depreciation till first quarter of
    the current financial year.
 Sporadic discussion on pricing is continuing in the IT sector. Growth is being driven
    by  lower value-added offerings.
Nomura expects market share-focused players (e.g., HCL Technologies, TCS and Cognizant) to continue to lead US dollar revenue growth (with 4.1%, 4.2% and 4.7% q-o-q growth respectively). Infosys is likely to see a lower growth differential in the second quarter (at 3.2% q-o-q). Wipro is likely to be the worst of the lot (at 1.8% q-o-q). 
On margins, Nomura expects Infosys to fare better (+70 bps q-o-q) against flattish trends at TCS and 80-170 bps declines at Wipro and HCL Technologies. This is likely to be due to wage hike impacts. 
On the bottomline, Infosys could fare better, in Nomura’s view, from hedging gains given substantial reduction in forward premiums on hedges over the last quarter and the company’s accounting policy of marking to market all hedging gains/ losses every quarter and taking it to the profit & loss account.
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