India Offshoring Quarterly Snapshot

Excerpts from Gilford Securities analyst Ashish R. Thadhani's recent note to clients on the Indian offshorers:

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MACRO OBSERVATIONS & COMPANY DEVELOPMENTS

The offshoring sector is in the midst of weathering a U.S. slowdown whose magnitude and length remain uncertain. Nonetheless, recent results and management meetings convey a relatively durable outlook: revenue growth of 19-38% in CY08/FY09 despite a pronounced short-term deceleration; stable pricing and declining wage inflation; and belief that macro pressures should trigger an urgent focus on cost rationalization and offshoring initiatives. We note that aggregate enterprise value of the four U.S. listed majors has rebounded 27% over the preceding quarter, while individual stocks have rallied 36-53% from their 52-week lows. This may also reflect improving Financial Services client activity, which had stalled after the collapse of Bear Stearns in March. Additionally, 6.9% QoQ rupee depreciation – stemming largely from soaring crude prices and moderating GDP growth – has provided a meaningful profitability cushion (~150-350 bps) although near-term EPS upside will be mitigated by existing currency hedges. In the current quarter, the Indian Finance Minister unexpectedly extended the “STPI” tax holiday by moving its expiration date from March 2009 to 2010. As a result, we are increasing our target prices and CY09/FY10 EPS estimates: Infosys (INFY) ($53) – from $2.55 to $2.65; Wipro (WIT) ($14.50) – from $0.70 to $0.73; Cognizant (CTSH) ($45) – from $1.80 to $1.92; Satyam (SAY) ($34) – from $1.60 to $1.72; and Syntel (SYNT) (none) – from $1.90 to $1.95. Finally, Hewlett-Packard (HPQ) announced that it will acquire Electronic Data Systems (EDS) for 18x CY08E EPS, rendering 20-24x for the faster growing and more profitable offshoring majors a bargain of sorts.

FAVORITE STOCKS

On the basis of projected upside, Cognizant and Satyam (+25% in 12 months) rank as our top bellwether picks at this time. Based on revisions to our calendar 2008 GAAP EPS estimates, Cognizant (no change) posted the best quarterly results.

MARKET INTELLIGENCE

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• Nasdaq vs. Sensex: despite a 28% correction, the BSE-30 index is up 8% YoY compared with a 5% Nasdaq drop.
• Valuation: function of global risk appetite and overall earnings visibility; forward P/E of 16x is in line with projected FY08-10 EPS growth.
• Foreign and domestic institutional activity: international interest in the Indian market has reversed after an extended spell.
• Nifty winners and losers: a majority of the top-10 performers for the March quarter were in the red.
• ADR premium (or local discount): explained by U.S. investor demand, peer valuations, market risk and absence of an arbitrage opportunity.
• Currency exposure: depending on a company’s cost structure, a 1% currency swing can impact operating margin by 20-50 bps.

MACRO INDICATORS

• Economic growth: long-term drivers are policy reforms & demographics; soft-landing scenario anticipates moderation to 7-8% YoY growth.
• BSE market capitalization: $1,284B at end-March or 1.1x forward GDP.
• Inflation: 8.8% as of end-May; recent hike in domestic fuel prices could push indicator to a 13-year high.
• Interest rates: choice of instrument signals a preference for combating inflation by reducing the supply of money vs. increasing its price.
• Dollar purchases by RBI: $78B (net) during the preceding four quarters.
• Forex reserves: $315B as of end-May.

ANALYST CERTIFICATION

I, Ashish Thadhani, certify that all the views expressed in this research report accurately reflect my personal views of the subject companies. I certify that I have not and will not receive compensation with respect to the issuance of this report.

Comments

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