IT gravy train will continue

The third-quarter results of various technology majors suggest that Nasscom's projections of $60 billion of IT exports by 2009-10 are achieveable. In 2005-06, exports hit roughly $23.5 billion. To make the 2009-10 target, overall revenues need to grow at about 26-27 per cent compounded. Is this possible?

It appears so, since in 2006-7, the companies have succeeded in maintaining 40 per cent-plus growth rates and that has accelerated in the October-December quarter. That's commendable given that three companies are already well over the $1 billion mark and others are getting there.

The domestic IT sector's pricing power has risen since billing rates rose by 3-5 per cent. Certainly the bigger firms are also looking for business (consulting, products), and new markets, which will enable both growth and higher margins. If we see the frantic hiring spree in the industry (9 million and counting), the guidance is not hot air.

The past results and future projections should reflect in overall valuations for the industry and in individual stock prices. Indeed, they do - but earnings growth has exceeded price-earnings discounts over the past year or so.

This may be the only industry where this is the case. What it implies is that an industry, which was a "buy" a year ago is even more of a "buy" now - despite a 43 per cent price appreciation.

In January 2006, the CNXIT was trading at a value of 3884 points and an average PE ratio of 40. By PE to earnings growth measures, this appeared full value at the time. By January 18, 2007, the CONX IT had climbed to 5565 and an associated PE of 33.7.

Factor in likely Q4 2006-7 growth of about 40-45 per cent and that PE and PEG looks moderate. The PEG is below 1, the projections are believable and the gravy train should continue.

The interesting thing is that the CNX IT hasn't outperformed broader benchmarks like the Nifty - it has given almost exactly the same return. However technology funds, which have traded IT stocks selectively, have produced returns somewhat better than the market.

What could be the worries on the horizon? IT-ITES is almost immune to a domestic slowdown imposed by rising rupee interest rates. It also appears near-immune to slowdowns in global economic conditions barring an absolute meltdown.

One may even argue that Indian companies will win more business if there's a global slowdown and CIOs / CFOs become more price-conscious.

Two areas of concern stand out. One is a squeeze in terms of the supply of skilled workers. By 2008, domestic IT may hit a wall and scramble to find enough engineers. The other is a major currency fluctuation that knocks income and revenue projections out of gear.

The first is predictable and I suspect, taken into account in projections, since everybody has talked about it at length. Be it in Begusarai, Beijing or Bulgaria, skilled personnel will be found. It will impact wage bills but that too is taken into account in projections.

It's the second - currency risk- that is an imponderable.  Since January 2003, the rupee has risen from the Rs 48 level versus the USD till about Rs 44 (it has dipped below 43.5 several times). To an extent, rupee weakness against the Euro and the sterling has compensated. But the bulk of IT exports come from North America.

Despite the loss in billing competitiveness and the direct impact on bottomlines, the sector has maintained its growth. But if there's a further rupee hardening, particularly a sharp trend, this may not be the case.

What the industry needs really is a degree of predictability about currency movements. It's possible to hedge and compensate predictable moves to a great extent by treasury management.

But treasury management is not a core activity and even the best IT companies may be caught flat-footed by a sharp move.

Also, billing rates cannot be changed anywhere near as swiftly as rupee-dollar currency positions.

This is where the whole concept of soft landings and gradual appreciation and depreciation come into play. IT would make the $60 billion target even if the rupee hardens by another 8-10 per cent by 2009-10, provided the hardening is gradual.