How the US fiscal cliff may give Infosys, Wipro an edge over TCS

Shares in software services exporters, which derive more than three-fourths of their revenues from the United States and Europe, are likely to be under pressure over concerns of the fiscal cliff in the US and the second recession that has engulfed most countries in the Eurozone.

Fiscal cliff refers to more than $500 billion in tax increases and across-the-board spending cuts that will automatically kick in after January 1 unless President Obama and the Republicans reach an alternative deficit-reduction deal. The sudden taxes and spending cuts may send the weak U.S. economy into a double dip recession, some analysts say.

Some corporates are not ready to commit to long-term IT spending till they have some clarity on the U.S. fiscal cliff as well as what's happening in the Eurozone, Hitesh Shah of IDFC Securities told NDTV Profit on Friday.

Given the dismal macro backdrop, IT spending is unlikely to go up significantly in the calendar year 2013, and this will limit the growth potential of India's top IT firms in their biggest markets.

"IT spending for the BFSI (banking, financial services and insurance) sector, particularly banking and capital markets in that vertical, is likely to fall marginally," Mr Shah added. The BFSI vertical is the biggest revenue contributor to top IT firms like TCS and Infosys.

The case for the laggards:

Over the last few quarters, TCS and HCL Tech have steadily gained because they have managed to outperform rivals Infosys and Wipro in a challenging environment. TCS expects to end fiscal year 2013 with a growth in excess of 11-14 per cent in contrast to Infosys, which sees dollar sales growth at 5 per cent.

Mr Shah said the growth rates of bigger companies like TCS and Infosys are likely to converge with each other.

"We may see a slight uptick in growth for Infosys and Wipro and a slight downtick in growth for TCS and HCL Tech," he added.

Investors have rewarded companies like TCS, whose shares hit a 52-week recently, and HCL Tech, whose shares hit a 12.5-year high on Thursday, on the back of the outperformance over peers. But the sharp rise in shares has also led to rich valuations for these companies. TCS trades at 17-times one-year forward multiple. In contrast, Infosys and Wipro trade at 11.5-13.5-times one year forward multiples.

"TCS will have to give a big positive surprise for the stock to move up from here, but even a small surprise from Infosys and Wipro will take the stock up 5-10 per cent over the next quarter or two," Mr Shah said.

IDFC has an "outperform" on Infosys and Wipro, and a "neutral" on TCS.

The case for IT mid-caps:

Mid cap IT stocks have done well primarily because of the rupee’s weakness. However, firms like Mindtree, Hexaware and eClerx have not done well because of negative surprises in quarterly earnings, Mr Shah said.

IDFC has a "buy" call on KPIT Cummins and Persistent Systems on the back of better revenue visibility.