INDIAN IT SERVICES：TAKEAWAYS FROM THE US 1Q BANKING RESULT SEASON FOR INDIAN IT
However, sustainability of this recovery and how quickly it willtranslate into higher IT spending is still unclear. Also, immigrationrisks are yet not factored into the estimates
We remain Hold on TCS, and Buy on CTSH and HCLT. INRappreciation is a risk as well
Banking sector recovery is the single most critical driver for IT stocks in FY18/19.Eventually, the extent of recovery could even overshadow the risk of immigration reforms(refer our 2017 outlook report, 2017 outlook: It’s a macro call). In that context, 1Q17results from the top banks in the US are encouraging. As seen in chart 1, in line with3Q/4Q16, top US banks reported improvement in revenue growth. Post a 7% decline inrevenues in 1H, the banks reported 3% growth in 2H16 and c9% growth in 1Q17.
Sustained recovery in revenue growth for banks is usually good for the tech spendingoutlook. In the past, we have seen a high correlation of tech spending with the revenuesof banks (tech intensity-tech spend to revenues ratio has been flat last few years for thebanks) – chart 2. A continued improvement in revenue growth of banks could triggerhigher tech spending and growth for Indian IT.Separately, cost cutting remains the focus for banks as non-interest costs declined forbanks for multiple quarters now – which could mean higher volumes for same dollars fortech work as well (implicitly means higher pricing pressure and automation).
Interestingly,operational costs have increased in 1Q17, after many quarters of decline.Focus on digital remains strong, but overall spend still a zero-sum game: As in thepast few quarters “digital” remains the focus for banks. Mobile banking customers are up~15% y/y for leading banks like JPMC and BoFA in 1Q17.collate the digital initiatives for banks. However all this spend is coming at the cost oftraditional spend as banks continue to reduce branches and staff and squeeze spend oncore banking investments. Overall, the expansion of tech pie will eventually depend onthe revenue growth of banks, as discussed above.
Overall, Indian IT companies in the recent 4Q17 results have alluded to “expected”improvement in demand environment in the coming quarters. With the improvementshown by the US banks in the past 2-3 quarters and likely rise in interest rates, demandshould get better, however the extent of recovery is still uncertain. Also some recovery isalready factored in. For TCS, incremental revenues factored into FY18 are nearlyUSD1.6bn, increase from USD1.4bn in FY17. On the other hand, in the near term theuncertainly around immigration reforms still remain high. Within our large-cap coveragewe like CTSH and HCLT – both Buy-rated.
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