US capex cycle booster for IT

The strength seen in the IT index since the start of this calendar is likely to remain intact, with the recovery in corporate capex and positive streak of earnings upgrades expected to expand price multiples for the sector.

According to Credit Suisse, the start of consensus earning upgrades for the sector, along with concerns on global growth abating, signals upside for the sector this year.

Sakthi Siva and Kin Nang Chik, analysts at Credit Suisse, believe Indian IT is one of the best ways to play the US capex recovery in an Asian context. “While we have been suggesting that the breadth of the US recovery is the best since 2008, the January rise in capex orders and the February rise in ISM new orders (from 53.3 to 57.8) suggest corporates are boosting capital spending after cutting back (from May to October, 2012), presumably because of concerns initially about Europe and later about the fiscal cliff,” they said in a note on Tuesday.

This pick-up in discretionary corporate spending is already being reflected in the sentiment and guidance given by managements of IT companies and industry bodies.

Nasscom has recently given a higher forecast of 12-14% revenue growth in fiscal 2014 as compared to 10% in fiscal 2013. Similarly, Gartner has forecast 5% growth in worldwide IT services this year as against 2% in 2012.

This has led to earning upgrades for the sector twice over the last two months.

“Apart from exposure to the US capex cycle and still modest premiums for HCL Tech and Wipro, we see another positive for Indian IT – the start of consensus EPS upgrades. While for India overall we are seeing flat revisions over the past two months, we have seen upgrades of 3.1% in January and 1% in February to 2013 expected consensus earnings per share for Indian Tech,” wrote the Credit Suisse duo.

Not surprisingly, the IT sector has been the best performing index giving 8% returns in the last one month compared with 2-3% fall in benchmark indices.

Experts see the outlook for IT remaining positive in coming months.

Rikesh Parikh, vice-president, markets strategy and equities, Motilal Oswal Securities, says that while there may not be any earnings upgrade, they see positive valuation for the IT sector on account of three main factors. “ First, the recent rupee depreciation has helped IT companies whose main clients are from US and Europe; second, Nasscom’s improved guidance for FY14, supported by all companies;  and third, no negative outlook from any company, showing positive growth going forward,” he said.

Similarly, the analyst at Credit Suisse believes that recent earning upgrades would trigger price to earnings multiple expansion.

“As seen in previous cycles, P/E multiples react disproportionately in this sector to small changes in revenue growth expectations and to the direction of consensus earnings revisions. Consensus has started moving up and we think that process can continue for some more time. Earnings upgrades driven by a pick-up in corporate IT budgets would potentially lead to a re-rating of earnings multiples,” they wrote in the report.