India IT Sector: INR Kicker

September 25, 2018 Technology India THIS REPORT HAS BEEN PREPARED BY KIM ENG SECURITIES INDIA PVT LTD SEE PAGE 30 FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS Stock Bbg MCAP Rating CMP TP Upside PE (x) ROE Div yield code (USDm) (INR) (INR) (%) FY19E FY20E FY19E FY19E Tata Consultancy Serv. TCS IN 109,330 HOLD 2,198 2,110 -4% 25.5 21.8 36.5% 1.4% Infosys INFO IN 43,269 HOLD 718 755 5% 18.5 16.2 25.9% 2.4% HCL Tech. HCLT IN 20,819 BUY 1,096 1,240 13% 14.5 12.4 26.5% 1.3% Wipro WPRO IN 20,698 HOLD 333 315 -5% 17.0 14.8 17.4% 2.0% Tech Mahindra TECHM IN 10,381 BUY 749 860 15% 15.7 12.6 21.0% 2.0% Mphasis MPHL IN 3,263 HOLD 1,189 1,230 3% 20.5 16.4 20.6% 2.1% Hexaware Tech. HEXW IN 1,862 HOLD 451 470 4% 22.3 17.2 27.7% 1.8% Cyient CYL IN 1,093 BUY 711 800 13% 18.3 12.9 17.8% 2.3% Persistent Systems PSYS IN 907 BUY 815 950 17% 16.7 12.9 17.3% 1.7% TAKE Solutions TAKE IN 368 BUY 166 285 72% 9.4 7.1 11.2% 1.4% India IT Sector INR Kicker Raise EPS by 0.5-8.2%; remain POSITIVE The USD has strengthened against most currencies YTD. Its appreciation against INR is positive for our IT service companies, though not its appreciation against EUR / GBP / AUD. While we cut USD revenue forecasts for FY19-21E by 0.8-1.3%, we raise INR revenue by 2.1–5.4%. Incorporating higher margins from INR depreciation, we raise EPS by 0.5–8.2%. We remain positive on the sector’s revenue and earnings outlook, anticipating catalysts from improving demand and deal wins. We upgrade WPRO to HOLD from SELL as we believe it is coming out of its bottom. We upgrade PSYS & CYL to BUYs from HOLDs following improving earnings. Top picks are TECHM, HCLT and TAKE. Raise EBIT margins by 37-113bps In our analysis, every 1% change in USD / INR affects EBIT margins by 20-40bps and earnings by 1.5-2%. Most companies hedge 6-12 months of their receivables through plain-vanilla forward contracts and options. Companies like INFO and PSYS take short-term hedges of six months or so while TCS, HEXW, WPRO and TECHM hedge for more than a year. Open positions are 25-30% of net exposure, with natural hedging falling in the 35-45% range. We believe the benefits to EPS will accrue from 2H19. We also believe INFO, TCS and TAKE will benefit the most. Cut USD & raise INR revenue for FX changes The USD has appreciated 2-4% against EUR / GBP / AUD QTD. This will have an adverse 0-1% impact on USD revenue for our companies, the least for TAKE and the most for CYL and TECHM, in our estimation. Thankfully, demand is improving, led by US GDP growth and higher corporate profits. Also several managements indicate that digital contracts have moved from proof of concept to full-fledged contracts. Further catalysts from digital deals The NSE IT Index has gained 37% YTD, outperforming all other sector indices. It trades at 18.2x 1-year forward EPS, close to 1SD above its 10-year mean of 19x. This suggests that some of the positives from currencies and demand may have been factored in. Still, we see catalysts from higher digital contracts. (At its peak, the sector traded at 22x, 2SD above its 10-year mean, though we are not expecting this anytime soon as revenue growth then was 18-20%). Analyst [Unchanged]POSITIVENeerav Dalal(91) 22 6623 2606neerav@maybank-ke.co.in September 25, 2018 2 India IT Sector Currency impact: upside & downside The INR has depreciated sharply in the last fortnight to hit a low of 72.9/USD. On average, every 1% change in USD/INR affects our EBIT margins by 20-40bps. Considering the current weakening of USD/INR, we raise our USD/INR assumptions to 71 for FY19-21E from 68. The USD has also strengthened against GBP/EUR/AUD. This could have an adverse impact on revenue, depending on the share of revenue in different currencies. While we cut USD revenue forecasts for FY19-21E by 0.8-1.7% for cross-currency headwind, we raise INR revenue by 1.6–5.4% for INR depreciation tailwinds. Overall, we raise EPS by 0.5–8.1%. Fig 1: Change in EPS and TP Particulars Bbg CMP Rating FY19E Chg FY20E Chg FY21E Chg TP Chg code (INR) New Old % New Old % New Old % New Old % Tata Consultancy Serv. TCS IN 2,198 HOLD 86.3 83.2 3.7% 100.7 94.6 6.5% 117.2 109.9 6.6% 2,110 1,990 6.0% Infosys INFO IN 718 HOLD 38.9 37.5 3.6% 44.4 41.7 6.6% 49.6 46.3 7.2% 755 665 13.5% HCL Tech HCLT IN 1,096 BUY 75.7 72.8 4.0% 88.6 83.0 6.7% 98.1 92.1 6.6% 1,240 1,160 6.9% Wipro WPRO IN 333 HOLD 19.5 18.8 3.9% 22.5 20.8 7.8% 24.5 22.7 8.1% 315 250 26.0% Tech Mahindra TECHM IN 749 BUY 47.8 46.8 2.1% 59.5 55.0 8.2% 66.8 61.8 8.1% 860 800 7.5% Mphasis MPHL IN 1,189 HOLD 58.0 56.0 3.6% 72.4 68.2 6.2% 84.8 78.8 7.6% 1,230 1,160 6.0% Hexaware Tech HEXW IN 451 HOLD 20.2 19.8 2.1% 26.2 24.4 7.4% 29.8 27.9 6.8% 470 440 6.8% Cyient CYL IN 711 BUY 38.8 38.4 1.0% 54.9 51.7 6.2% 66.8 62.0 7.8% 800 725 10.3% Persistent Systems PSYS IN 815 BUY