ALL EYES ON IT RESULTS AS EXPERTS WORRIED OVER FUTURE OUTLOOK

Rajesh Menon, Bangalore
The Financial Express

As the curtains go up on the September-December 2007 quarter earnings season, and with India’s IT bellwether Infosys Technologies set to detail its results on Friday, the main focus would not be on the numbers that top-tier software exporters reel out, but on the management commentary. While analysts and industry experts see the performance of frontline IT companies in line with expectations, what they would want to know from the managements of these companies is what is in store for the next financial year.

With the US economy — the largest market for Indian IT companies, accounting for nearly 66% of its revenue—- heading into a possible slowdown compounded with the subprime woes that may force some large banks and global financial institutions to cut their IT budgets due to credit problems, the key look-out would be the visibility ahead.

“While a good third quarter is the consensus, the focus would be on visibility for financial year 2009 and comments on customer budgets for 2008,” global investment bank JP Morgan said in its preview of the IT sector ahead of the third-quarter results. “With no surprises in Q3 performance, the focus would be on the commentary related to the demand environment and the possible fallout of (the) subprime issue,” domestic brokerage house Sharekhan said in its report.

The reason has been that most Indian IT companies have given positive commentary on the third quarter and there has not been a marked difference in the demand environment in that quarter that would have made an impact. “(The) IT services demand environment remained decent in the December quarter (evinced in Accenture’s good results) and we estimate strong 7-10% quarter-on-quarter $-based revenue growth from large Indian IT players,” the JP Morgan report said.

“We expect top-tier IT companies to report continued strong sequential topline growth in the third quarter, even as this is traditionally a slow quarter, given that it is the holiday season and, therefore, has a lower number of billing days. The growth in dollar terms is expected to be an impressive 8.9% on a sequential basis,” says Harit Shah from Angel Broking.

Revenue growth of these companies for the third quarter will primarily be driven by volumes along with margins moving upward as the rupee traded in a narrow range between Rs 39 and Rs 40 (an appreciation of 0.6% in the end-to-end period and 2.5% on an average in the quarter), wage increases getting normalised and utilisation rates going up.

“We expect top-tier software companies to see a rise in earnings before interests, tax, depreciation and amortisation (or, Ebidta) margins in the range of 30-125 basis points on a sequential basis as they have multiple levers of margin defence,” says Shah. JP Morgan said they expect around a 50-basis point increase in margins for Infosys and TCS, 170 basis points for Satyam as the company normalised its salary hikes given in the second quarter and margin declines from Wipro due to staggered salary hikes and acquisitions (a lower margin for Infocrossing that it acquired in August for $600 million).

“While concerns about the US could have a negative impact on discretionary spends, this would begin to impact from the March quarter, in our view. On the pricing front, we expect some increases at Infosys, TCS and Satyam while Wipro should see a decline due to a lower number of billing days,” the JP Morgan report said.

In light of the US credit meltdown and big write-downs by large global banks; the key factor for the sector has been the outlook for calendar 2008. However, Indian IT companies have constantly maintained that they have not seen any slowdown or project cuts from customers. Considering the stance taken by these companies, Indian software majors will harp on the “cautiously positive” commentary.

Even as managements repeat a cautiously positive commentary, there are certain points that have to be keenly watched. To begin with, a close eye has to be kept on the financial sector revenues and business from the US for second-tier firms. The financial sector is the largest contributor of revenues for most large Indian IT companies.

Pricing is another important data point that will reflect on companies’ growth momentum. “We expect some improvement in billing rates, which will primarily be driven by an improving service mix.