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Valuation of IT stocks like TCS, Infosys at historic lows, not much downside – Edelweiss

Stocks of Indian IT service providers like Tata Consultancy Services, Infosys Ltd, HCL Technologies etc. are near their historic lows in terms of valuation and do not have much more scope for further correction, Edelweiss Financial Services said.

“IT stocks have corrected sharply in the past couple of months led by INR appreciation and portfolio shifts. While we acknowledge that rupee appreciation will impact earnings of large-cap IT players in the 2.5-5.0% range, we do not expect a further decline in trading multiples as they are currently close to historic lows of post Lehman crisis, while the current situation is almost opposite as demand is on a strong footing,” the brokerage said in a note.

It said domestic demand and initiatives by the new government like restoration of STPI status, uniform taxes and improved relations with the US to be helpful to the IT sector.

IT-stock-valuation-india

IT stocks have corrected nearly 10% since Modi came to power due to the rise in the value of the rupee. This correction has come after they fell substantially since February this year due to the chances of a turnaround in the Indian economy. IT stocks typically fall when Indian does well, as money is reallocated to India-oriented stocks.

Edelweiss said it was reducing earnings estimate for large IT companies by 2.5-5.6% to factor in INR/USD of 58 and 56 for FY15E and FY16E, respectively.

“Based on same, we are revising target prices of Infosys, TCS, Wipro, HCL Tech and TECHM to INR4,307, INR2,538, INR581, INR1,591 and INR2,229, respectively,” it said.

Contrary to FY09, currently demand is on a firm footing riding US recovery and new technologies. “Hence, in our view, the chance of further multiple de-rating is limited and the impact of INR appreciation will be limited to 2.5-5.0%, which caps the downside risk to 5-9%.”

Edelweiss said Narendra Modi, the soon-to-be-elected Prime Minister, in all recent interactions has emphasized the need to revive exports. So “a stable currency is a natural corollary. Also, his effective use of IT in Gujarat to reduce human interface to a great extent as well its aggressive use in his campaigns—3D meetings, social media interactions —bodes well for the domestic IT space. Increasing role of IT in governance will boost domestic IT spending, which is bound to impact the sector positively.”

It said there were a few pain points hampering execution, which the new government will need to address.

“On top of the wish list of IT companies are: (a) restoration of STPI benefits; (2) relief from applicability of both service tax and VAT on software licences; and (3) better diplomatic engagement with US to avoid harsher immigration clauses. Based on our analysis, we believe resolution of these issues will enable IT companies to not only enhance their earnings by 2%, but also smoothen execution.”

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