Is IT's future cloudy on stock market

Is IT's future cloudy on stock market

Is IT dead? And is the stock market about to write the obituary of the information technology (IT) sector? Or, has it already done it? The sector, which appeared almost invincible not so long ago, is now under siege from investors and analysts alike.

Valuations of IT companies:

Its future prospects have also come under a cloud on fears that the US economy is hurtling towards a recession which, in turn, will trigger off a global economic slowdown.

Valuations of IT companies:

So, are the curtains finally coming down on the sector, or is there still some steam left? ETIG tried to find the answers to these questions and concluded that all is not over for yesteryear's poster boys of Dalal Street.

IT stocks were laggards in '07, even as the broader market continued to witness a bull run. The 30 components of the ET Infotech index lost over 5% during the year, while the BSE Sensex gained 45.5%. IT scrips could not escape the recent bear hug as well. Here again, the 20% drop in ET Infotech was sharper than the 13% fall in the Sensex. The market turmoil has also caused these scrips to trade at historically low price-toearnings (P/E) multiples.

Interactions with industry observers and analysts reveal a common thread. There seems to be a consensus that stocks of IT exporters, especially the top companies, are attractive at the current levels for long-term investors. The argument is largely based on the commonly used P/E valuation method.
Most of the IT stocks are currently available at deep discounts to their historical P/Es (see adjacent table). In the case of Tata Consultancy Services (TCS), Wipro and HCL Tech, the current P/Es are half of their historical P/Es. This looks interesting, given that the Sensex is currently trading above its four-year average P/E levels, even after the recent crash.

One argument to support the downward revision in IT valuations is that earnings growth of these companies has come down over a period of time. During '05-06, quarterly earnings of the ET Infotech index were growing by an average 50% annually. The growth moderated to over 33% by the middle of '07-08. This is partly due to a higher base. Also, the rupee's appreciation has been dragging the growth down since the June '07 quarter.

A comparison of the quarterly earnings of the ET Infotech and the Sensex reveals that the former has started growing at a slightly lower pace than the latter. During the September'07 quarter, the Sensex profit after tax (PAT) growth outpaced that of the ET Infotech by a few notches. This pattern continued in the December'07 quarter as well.

The Rupee bogey :

The steep appreciation of the rupee in a short span of time has retarded the growth of IT exporters. This is evident from the fact that while growth in rupee revenues has come down, growth in dollar terms has remained strong. Growth in the banking, financial services and insurance (BFSI) space during the December '07 quarter was decent, despite the subprime woes in global financial markets.

This sounds assuring enough, since the banking and financial segment is the major revenue stream for Indian IT companies. Moreover, IT companies have been able to curtail the impact of a stronger rupee on their profitability. On an average, a rise of 100 basis points (bps) in the rupee against the dollar pulls operating margin down by 30-45 bps in case of top IT companies. Hence, an overall increase of 11% in the rupee should have reduced the profitability of IT companies by 300-450 bps. Source: Internet