Tech worries are back ahead of the second quarter…

Between the guidance from Accenture a couple of days ago and the guidance from HCL Tech today, there is one thing in common. There is a distinct worry that growth may disappoint for TT both on the top-line and the bottom-line. With Infosys normally, the first off the block as far as QQ are concerned, there are quite a few data points that will be closely watched.

Cross currency headwinds…

This is a new complication that has arisen for technology companies as their non-US business has spread quickly in the past few years. As long as the business spectrum was predominantly US markets, a weak rupee and a strong dollar tended to benefit these tech companies substantially. Today most of the leading technology companies derive a good chunk of their revenues from Europe and Japan and these are predominantly denominated in Euros or in Japanese Yen.

As the US dollar has continued to strengthen versus the Euro as well as versus the Yen, it has posed a new problem for Indian companies. Companies with revenue billing in Euros or Pounds tend to lose out when the dollar appreciates versus these hard currencies. With expectations of a US rate hike in December gaining currency, the US dollar continues to strengthen adding to losses for technology companies due to cross-currency headwinds.

IT investments continue to be slow…

In fact, Gartner has pointed out that IT companies from India are likely to be negatively hit by the slowdown in IT spending by US and European companies. This is not only likely to compress the top-line but also compel these large companies to bargain for thinner margins from service providers. Telecom and energy are two sectors that have seen a substantial slowdown in IT spending and this is unlikely to pick up in the near future. Secondly, the traditional BFSI space is largely saturated and does not offer too many opportunities for business alpha. Lastly, the digital segment, which is touted as the future of IT, is just about 2-3% of the total business mix of Indian IT companies and it may be years before this particular segment attains economies of scale. In the next few quarters, the pressure on the top-line as well as the margins is likely to continue.

Valuations are not too cheap, either…

If you observe the leading IT companies in India like TCS, Infy, Wipro and HCL Tech; all these stocks are facing a valuation roadblock ahead. Their ROE and growth is largely factored into their P/E ratios at above the 22-25 levels.  Unless these companies are able to generate an earnings surprise, it is unlikely that there could be any meaningful re-rating of P/E ratios for Indian IT companies. The major IT companies have reached a stage where their ability to propel their ROE or earnings growth substantially is limited. This would mean that valuations are likely to be capped and stock prices could be in a range.

 Why HCL Tech narrates a bigger story…

The warning issued by HCL Tech and Accenture is actually a broader indicator of the shape of things to come. Currency volatility could hurt many IT companies as other hard currencies weaken versus the US dollar. A general economic slowdown in world GDP means that IT investments are going to be hard to come by; and they are likely to come at a price. But the biggest story could be that any valuation re-rating for IT companies is unlikely to happen in the near future. At best, they may be defensive bets in a global economic scenario where the dollar continues to strengthen. What could be the next big story for IT companies could actually be the billion dollar question.

You can ask us your stock related questions with #AskReligareOnMarkets via our Twitter channel @religareonline

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