Excerpts from Gilford Securities analyst Ashish R. Thadhani's recent report to clients on the Indian offshorers:
• • •
MACRO OBSERVATIONS & COMPANY DEVELOPMENTS
International investors have soured on the Indian market (down 31% in 2008) due to legitimate concerns: slowing growth; uncontrolled inflation; fiscal indiscipline; and the ugly, destabilizing forces of coalition politics. For the export-driven offshoring sector, deepening global macroeconomic uncertainty suggests that any bias to short-term estimates is likely to remain on the downside. Uninspiring trends have included decelerating revenue growth, lengthening decision/ramp-up cycles, subdued hiring (0- 4% QoQ) and diminished pricing upside. Still, guidance implies relatively durable 3-6% QoQ revenue growth through fiscal year-end – not to mention rising market share vs. global competitors; meanwhile, healthy pipelines lend support to the powerful “cost rationalization” thesis playing out in CY09/FY10; and inexpensive valuations by historical standards – currently 16x forward EPS compared with 14x for the S&P-500 – should begin to discount a recovery by six- to nine-months. Longer term, NASSCOM is forecasting respectable 15% compound growth in IT employment through 2018. As for the $753 million cash offer for LSE-listed Axon by Infosys (INFY), we note the reasonable valuation of 14x forward EPS and 1.5x revenue; a virtual doubling of its fast-growing SAP consulting practice along with enhanced “transformational” capabilities; and better qualitative balance, i.e., 65% non-U.S. revenue plus addition of local talent. Finally, while offshoring has become an accepted element of global business, we expect that sentiment toward the sector could fare better under a McCain/R administration.
FAVORITE STOCKS
On the basis of projected upside, Cognizant (CTSH) (+64% in 12 months) ranks as our top bellwether pick at this time. Based on revisions to our calendar 2008 GAAP EPS estimates, Wipro (WIT) (+2%) posted the best quarterly results.
click to enlarge
- Nasdaq vs. Sensex: the BSE-30 index has corrected 34% from its January high – and is down 10% YoY compared with a 13% Nasdaq drop.
- Valuation: function of global risk appetite and overall earnings visibility; forward P/E of 15x is supported by 17% est. EPS growth in FY08-10.
- Foreign and domestic institutional activity: international interest in the Indian market has reversed after an extended spell.
- Sector winners and losers: IT moving back into favor.
- 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.
- Economic growth: long-term drivers are policy reforms & demographics; soft-landing scenario anticipates moderation to ~7% YoY growth.
- BSE market capitalization: $1,019B at end-June or 0.9x forward GDP.
- Inflation: 12.1% as of end-August; policymakers are targeting improvement to the 7% level by March 2009.
- Interest rates: monetary policy bias remains toward tightening.
- Dollar purchases by RBI: $73B (net) during the preceding four quarters.
- Forex reserves: $297B as of end-August.
- Growth: Satyam owns best record (9.0% LTM QCGR).
- Profitability: wide range explained by management, scale and reinvestment philosophy; productivity levers include employee- and offshore-mix.
- Attrition: indicates easing wage inflation, which has translated into ~300 bps of margin pressure annually.
- Offshore price realizations: a potential margin lever, driven by business-mix and ramp-up of newer clients.
- Outlook: $60B NASSCOM target implies 22% compound growth in FY08-10 and 20% market penetration; FY08 GDP contribution = 5.5%.
- Prevailing sentiment: conveys concern over a U.S. economic slowdown – and longer-term shortage of employable graduates.
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.
