Commenting on the Indian IT picture, Bhavin Shah of JP Morgan said Indian IT companies would see sharp pricing pressures in the fourth quarter of FY09. Shah also said that he sees price reduction in the range of 5-20% in 2009, which may be in a mid to high single digit, post discussions.
Here is a verbatim transcript of the exclusive interview with Bhavin Shah on CNBC-TV18.
Q: Would you go in a little light on IT stocks into that guidance? Do you think it might be a very circumspect one from Infosys for the next fiscal?
A: The guidance is suddenly going to factor in the aspects of uncertainty, so we would imagine that companies would firstly be conservative and secondly they might widen the range. But having said that, our sense is that the international investor base is sort of under an impression of assuming even as much as maybe a 10% year-on-year (YoY) Earnings Per Share (EPS) decline. So, I don’t think there is going to be a big shock to the market in terms of the guidance.
We have been cautious in the near-term for the space, given especially the March quarter is particularly tough, but we can easily see there is a fairly sharp price impact maybe as much as 5%, and that is why we think that in the near-term there is limited upside potential. In fact, we would have thought the stock might even pullback, although that doesn’t happen. But as far as the guidance is concerned, our view is that it is unlikely to have a big negative shock at this point.
Q: In terms of your channel checks with how business is progressing though, how high would you rate the chances that some of these IT companies actually discontinue the practice of putting out a guidance and say things are completely uncertain, we will get back to you when they are more clear?
A: I think that might happen with some of the smaller companies but I doubt that companies such as Infosys or Tata Consultancy Services (TCS) are going to stop at least the annual guidance that you get. I think that will probably continue and as I said earlier, the range might widen and what seems to be happening with some of the customers is that they are asking for price reduction but the negotiation seems to be in the range of asking for also more volume, more offshore. That trend seems to be certainly accelerating as a lot of customers face high pressures on their cost structure. So, I think while it is clearly a tough environment out there, it is not one where the company simply cannot give any guidance. So I would be very surprised if we don’t get guidance.
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Q: What is your sense of how much by way of a pricing cut might have been agreed to by some of these IT companies?
A: The range of price reduction that is being asked by customers, we believe, is anywhere between 5%, or the minimum, to as much as 20%. However, it is not that negotiations are concluding at 20%. We think that most of the price reductions appear to be in the range of mid to high single digits. So I think that is where it seems to be working out. However, in exchange for agreeing to price cuts, I think in many cases the company seems to be able to get additional offshore volume as well. So I think we could still see some bit of volume growth, or at least, flat to slight increase in volume in next fiscal year.
Q: If indeed prices are going to be cut by 7-8%, how of that can be off-set by consequent salary reduction closer home, so that its margin is neutral and does not show up in the profitability for the next year?
A: If you assume basically about 5% cut in the salary that can essentially off-set the large part of the price cut that they have to face. So, I believe that rather up to 5% of price cut can be absorbed by the salary cuts that we think the companies are planning to take. So, there is some margin impact but then there is rupee benefit as well. So the margin story doesn’t look too bad at all, I think margin holds pretty okay.
Q: The relative performance of the largecap names has been quite interesting while Infosys is relatively far more stable between Rs 1,200 and Rs 1,300, it is Wipro which is getting beaten out of shape; any particular reason?
A: I think there might be some customer specific situations. Wipro’s exposure may be to customers such as UBS that might be having a bigger impact. So, that is probably one reason.
Second reason is that the preference for company that has managed to grow well even in a tough environment, so obviously that comes back to Infosys which has had the best track record in terms of delivering performance in a tough environment.
Q: There has been expectation for a couple of these IT companies that come FY10 there might be a positive pop because of what has been happening with the currency, hedging gains, etc. Would you say there could be a meaningful impact on any of these companies and which one would stand out in that according to you?
A: In terms of positive impact of the currency, I think in terms of reducing the hedge exposure Infosys have been most noticeable and Satyam was as well. But we don’t cover Satyam at this point. But Infosys is most noticeable, so I would imagine that it would benefit the most as well.
Q: What is it that you are picking up by way of budget spends right now because in our last few interactions with the IT companies they have indicated that things haven’t gotten frozen up quite yet, what would you expect to see in terms of a budget spend cut?
A:I think in some cases it is still on an ad-hoc basis. There are no annual budgets that are being planned. Situation is still evolving on a quarter-to-quarter basis. But I would say that overall IT budgets are definitely going to decline anywhere from, at least, 10% decline we can assume for the US IT spending by corporates. However, that is a big pool of number and there are a lot of things that go inside that number. If you look at the offshore portion though, it is possible that offshore value could actually increase because at least in some cases we are seeing pretty significant increase in offshore proportion.
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Q: How will midcap IT companies come out of this while they may not give guidance because of lack of visibility? The way these stocks--NIIT, Rolta, Hexaware--have been butchered these last few weeks, is the market right in sensing that they will actually not come out of this very well, nearly as much as an Infosys or a TCS may be able to negotiate?
A: At least in a next few quarters, the smaller companies will face a bigger impact because we do notice that there is some bit of consolidation that is also happening. In order for the big companies to agree to price cuts they are asking for more volumes and customers, in some cases, are responding by consolidating their vendor base as well.
So I think that definitely puts the small companies in a difficult position here. Obviously, ultimately when we do get that there is more of a broader recovery they can probably have a chance to gain some more traction but a near-term outlook for them is going to be tough.
So without going into specific names, I want to say that every single stock has gone down correctly or by right amount but generally the risk of weaker performance, outright declines is pretty high for midcap companies on year-on-year (YoY) basis.
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