Top six factors why Jefferies is positive on Indian IT sector; TCS, HCL, Tech Mahindra top bets

NEW DELHI: Jefferies remains constructive on the Indian IT sector on the back of strong hiring trends, increased outsourcing from Europe, improving US economy, trend towards digital technologies and a stable large deal market.

IT services earnings remain leveraged to revenue growth, which also receives the maximum investor focus, said the report.

The global brokerage firm remains positive towards companies that have shown the best deal win and revenue growth momentum such as TCS, Tech Mahindra and HCL Technologies, which are buy calls, while it rates Infosys and Wipro as ‘holds’.

Jefferies has listed top six factors which make them constructive on the IT sector:

Outsourcing from Europe

Europe has outpaced on growth over the past 4 years, a trend likely to continue. This is on the back of both lower outsourcing and even lower offshoring. Increased focus from the Indian vendors to improve presence in Benelux, Nordics and E Europe should sustain growth momentum.

Capital allocation - dividend, buyback and M&A

This has been necessitated by the improving cash flows and accumulation of cash on the balance sheet. Jefferies believes that while Infosys has already indicated sharing its capital allocation plan in the future, other companies may follow suit over a period of time. The Top-4 Indian IT firms have added INR217bn (USD3.5bn) in incremental cash in FY14.

Hiring trends indicate healthy demand

Hiring trends across the Top-5 Indian IT companies have seen a significant improvement over the past few quarters, indicating that companies are planning for robust demand ahead despite the arguments of high utilization rates prompting this hiring.

Lateral hiring too has seen a strong pick up over the past two quarters at TCS and Infosys, a direct correlation to the ramp up or expectations of a near term ramp up across these companies.

Trend towards digital

The growing proportion of Social, Mobility, Analytics, Cloud (SMAC) spend and the prolific growth forecasts underline its importance in the market landscape into the future. NASSCOM estimates suggest that SMAC alone could become a US$1tn opportunity for Indian IT services vendors, an 8x growth in 8 years.

However, trends in two early adopters of digital - retail (which has not shown a growth pick up) and banking (which has faced recent regulatory pressures/fines) - would need to be watched for.

Large deal market and IMS

The impact of large deals and its ability to create a differentiation in the relative growth of companies have been the key over the past five years. This has benefited the Indian vendors who have seen increased invite and bid rates, a trend likely to continue along with importance of infrastructure management services in large deals.

Currency swings and macro

The movement of the USD against the INR and a basket of other currencies would play an important role in both reported INR earnings. The strengthening of the USD towards the end of 2014 should continue, and influence both revenue and earnings trajectory for the sector.

Macro fluctuations - oil price fall and increased sovereign risks in some European countries, the reason for these currency swings, could also have an impact on the sector sentiment.

(The above report was compiled from inputs from Jefferies released on January 14, 2014)