March Sector Report IT Services f - Edelweiss

March 2021

Edelweiss Securities Limited

Sector Report

IT Services

Techolution: The cloud fission

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Sandip Agarwal+91 22 6623 [email protected]

Pranav Kshatriya+91 22 4040 7495

[email protected]

Pulkit Chawla

[email protected]

Edelweiss Research is also available on www.edelweissresearch.com, Bloomberg - EDEL, Thomson Reuters, and Factset Edelweiss Securities Limited

IT

Cloud fission to spur 16–17% CAGR?

Our cover page pictorial representation is of a chain reaction, which gets triggered

by hyper scalers, and is similar to the fission reaction that undergoes in a nuclear

reactor. We believe based on our several interactions with global

technologists/hyper scaler experts that cloud sales of hyper scalers can lead to 3

times services revenues spread over next 5–6 years. Moreover, the chain reaction

of hyper scalers cloud sale is irreversible, similar to the chain reaction in a nuclear

reactor. The above equation when translated into numbers imply a USD1 trillion

opportunity for technology services, which translates into USD250bn for global

sourcing and approximately incremental USD175bn for Indian IT services, in turn

implying doubling of revenues from current USD150bn of exports or a five-year

revenue CAGR of 16–17%.

(3𝑛

2 ∗ 5) ∑

5

𝑥=1

∑𝛽𝑦

𝑥

𝑦=1

Where β1= 1 ; β2= 1.2β1; β3= 1.15β2 and βy>3 = 1.1β(y-1)

What our ‘Technology Ecosystem’ says

We diligently follow our set up procedure to revalidate our thesis every quarter, and

make a reasonable effort to cover all industry verticals, service segments and

geographies to find outliers, if any, in our thesis. We also ensure that while we get

the immediate picture right, we do not miss out on any deviation in clients’ five-year

spending plans (our track record of feedback has been good; refer to page 14–22).

Our quarterly exercise indicates the following:

Our recent (re)interactions with the who’s who of technology spends across

geographies and verticals reinforce the Techolution thesis (link). Such interactions

over the past 45 days indicate that technology spends are accelerating triggered by:

i) higher cloud adoption across industries/verticals/geographies; ii) substantial jump

in tech spends led by BFSI’s renewed propensity to spend, also spurred by hyper

activity from fintech players; iii) sharp bounce-back in manufacturing and product

engineering services; and iv) retail refocusing on core infrastructure as well as digital,

while telecom and energy spends remain subdued. Also, most CTOs have shown

extreme urgency to make the first move to cloud, reflected in hyper scalers’

revenues. However, the second wave of covid-19 has kept implementation slow,

leading to a sudden jump in deal award activity for outsourcers.

We reiterate—again enthused by emerging and reassuring evidence—that the mega

technology upcycle has just gotten underway. IT companies across the board have

started acknowledging that the margin improvement is more structural than anticipated

earlier. Consensus forecasts, though, are still building in revenue growth and margins

much lower (~150bps) than what companies themselves are indicating. This reality-

consensus mismatch again raises the odds of a big outperformance in Q4FY21 (barring

the currency risk), akin to the preceding three quarters and of 10–15% quick potential

returns by IT stocks over and above their roaring gains since May. Ride the Upcycle.

Margins to rise; execution savings higher than incremental costs

We estimate margins of key companies in our coverage to improve 250–350bps in

the next three years over FY20 levels and believe current consensus earnings

forecasts are still 10–25% lower, even in the base-case scenario. Our optimism on

Cloud fission implies doubling of industry

revenues in five years

Our technology ecosystem feedback has

been spot on in the past

Client spend momentum remains robust

https://www.edelresearch.com/showreportpdf-46278/IT_-_SECTOR_UPDATE-JUN-20-EDEL

IT


2 Edelweiss Research is also available on www.edelweissresearch.com, Bloomberg - EDEL, Thomson Reuters, and Factset

margins is based on the following: i) sustained moderation in sub-contractor costs;

ii) stable wages at the bottom of the pyramid; iii) massive physical and virtual

training capabilities enabling lower skilling costs; and iv) opening up of talent pool in

tier 3-4 towns and narrowing gap between EBITDA and EBIT margins owing to lower

capex and depreciation, and substantial savings in overheads.

Key risks to our thesis: Broadly remain same

Serious data breach in the global technology ecosystem (FAANGS), adverse currency

movement, sharp depreciation of USD vis-à-vis INR and other currencies, substantial

cut in US technology budgets, particularly in digital, adverse regulatory provisions

and visa restrictions in key client markets could affect capability of Indian IT

companies to execute profitably.

Recommendations and conclusion: Just beginning of tech upcycle

We don’t have a negative view or ‘REDUCE’ on any of our under coverage stocks and

strongly believe that each company in the sector stands to gain from the powerful

tailwind that continues to gain heft. This tailwind will benefit one and all—and we

have been reiterating this through our Techolution series (World of apps dated June

8; Wave before storm dated September 2; Multiple Multipliers dated October 11).

A substantial rub-off effect on mid- and small-size companies would be in order too

aided by cost structure innovation and their high earnings sensitivity to margins. We

maintain ‘BUY’ on HCL Tech (TP INR1,616) Infosys (TP INR2,124) TCS (TP INR4,176)

Wipro (TP INR550), Tech Mahindra (TP INR1,450), LTI (TP INR4,732), LTTS ( TP

INR2,994) and Mindtree (TP INR2,821).

Edelweiss estimates

Revenues EBIDTA PAT EPS

CMP FY21 FY22 FY23 FY21 FY22 FY23 FY21 FY22 FY23 FY21 FY22 FY23 TM TP Upside

(%)

TCS

2,924

16,50,475

18,47,536

20,22,534

4,67,824

5,37,750

6,03,979

3,43,861

3,91,716

4,39,169

92

104

117

40

4,176 42.8%

Infosys

1,267

10,05,424

11,81,017

13,54,005

2,81,598

3,30,458

3,85,453

1,97,840

2,40,367

2,87,337

47

57

68

36

2,124 67.6%

HCL Tech

930

7,58,935

8,47,577

9,42,543

2,02,715

2,17,531

2,46,109

1,37,002

1,50,011

1,72,021

51

55

63

28

1,616 73.8%

Wipro

414

6,16,989

6,74,913

7,26,412

1,46,505

1,67,303

1,79,570

1,08,725

1,27,295

1,33,213

19

22

23

25

550 32.9%

Tech

Mahindra

936

3,80,777

4,15,218

4,50,514

68,432

77,886

85,298

46,035

49,782

56,071

52

56

63

25

1,450 54.9%

LTI

3,608

1,22,849

1,40,906

1,62,656

26,934

31,525

38,593

18,919

22,187

27,824

108

126

157

35

4,732 31.2%

LTTS

2,578

54,582

64,846

74,337

9,832

14,190

17,043

7,290

9,872

12,512

69

94

119

30

2,994 16.1%

Mindtree

1,634

79,667

93,585

1,05,615

16,272

19,633

22,362

10,884

13,010

15,062

66

79

91

35

2,821 72.6%

Persistent

1,687

41,944

48,025

55,109

6,566

7,676

9,656

4,261

5,155

6,353

53

64

79

30

2,166 28.4%

Cyient

652

41,294

46,078

51,762

5,916

7,201

8,428

3,637

4,618

5,398

32

41

48

18

801 22.9%

Eclerx

936

15,556

19,274

21,002

4,104

4,634

5,031

2,730

2,888

3,158

78

83

91

20

1,640 75.2%

Source: Edelweiss Research

We maintain our bullish view



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IT

Edelweiss Research is also available on www.edelweissresearch.com, Bloomberg - EDEL, Thomson Reuters, and Factset 3

Rationale behind our thesis of industry clocking 16–17% CAGR

Financial equation of reaction in cloud reactor:

If n=200bn (assumed hyper scalers’ cloud revenues in base year), y=year, X axis =

plotting services revenues from year 1 to 5; and Y axis=Hyper scalers’ revenue from

year 1 to 5, then it implies USD1 trillion of opportunity for technology services.

Then,

(3𝑛

2 ∗ 5) ∑

5

𝑥=1

∑𝛽𝑦

𝑥

𝑦=1

Where β1= 1 ; β2= 1.2β1; β3= 1.15β2 and βy>3 = 1.1β(y-1)

Yes, the above is a financial equation of the pictorial representation of the chain reaction

that takes place in a nuclear reactor. We believe the impact of cloudification on global

technology spends closely resembles the above chain reaction and we call it “Cloud

reactor”. Global technology experts/CEOs believe that the follow through revenues for

technology/allied services is almost 3x of revenues of hyper-scalers (AWS, AZURE, GCP,

IBM and others). Interestingly, of the above, at least 1.5x are technology services and

balance allied services/products, but spread over five-six years. When we plot the above

revenues in an equation like the one attempted above, it closely resonated into a chain

reaction similar to the fission reaction that undergoes in a nuclear reactor.

The most important aspect of the above “nuclear reactor” which is comparable to

our thesis of “cloud reactor” is the irreversible/unstoppable nature of the fission

reaction which it undergoes ones triggered. In a “cloud reactor” also, similar to a

“chain reaction”, once a reaction is triggered in a reactor the fission can’t be

controlled; similarly, once a cloud subscription is sold, the follow-on revenue is

irreversible and unstoppable. The above nature of cloud business gives us the

confidence once again to reiterate our view that the current “ Techolution – Tech

Upcycle” is not any up-fronting of demand or a temporary phenomenon, but a very

long (three-five years) robust spend cycle.

The above equation, if translated into actual numbers, implies almost USD1tn of

additional spends from cloud over the next five-six years. Of this, global sourcing

at current rate of 25% should be USD250bn and India’s market share at current

rate of 70% should be incremental USD175bn (from current USD150bn exports),

implying Indian IT industry’s five years’ CAGR of 16-17% and superior growth rates

for our preferred picks.

Based on the above equation (which has been built based on innumerable inputs

from global technologists/experts/deal advisors) we believe even in a bear-case

scenario, Indian IT exports (current USD150bn) will double to USD300bn, a number

which Nasscom has also projected. In fact, our base and bull case assumptions imply

16% and 17% CAGR, respectively. But, the bigger story is the historical data which

clearly indicate that large Indian IT companies have outgrown industry growth rate

by 3-4% in the past. The above implies that 20-22% sustained revenue CAGR for

stronger/niche players is a realistic possibility going forward with stable margins (ex-

wild swings in currency / regulations).

The above implies that similar to what happened in 2009-16 where one-year forward

multiples looked insanely expensive were much below fair value if the high growth

of the cycle was discounted and hence gave away 10-15x return during the phase of

the cycle (2009-16; TCS, HCL and Tech Mahindra went up 10x, 14x and 16x

respectively- refer to, Techolution: Multiple Multipliers).

The chain reaction in Cloud is similar to

fission in a nuclear reactor

We slightly more bullish than Nasscom on

the industry view


IT



Nasscom IT exports continue to be robust

USD bn FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 CAGR over

FY06-21

Nasscom IT Exports 24 31 41 47 50 59 72 77 88 98 108 117 126 136 147 150 13.1

Growth (%) 33.3% 32.6% 31.0% 14.6% 6.6% 18.7% 21.2% 6.7% 13.8% 12.1% 10.1% 8.3% 7.7% 7.9% 8.1% 2.0%

Source: NASSCOM

IT outsourcing penetration- Gain continues

Source: Gartner

Top Indian companies outpacing exports growth

Revenue Growth (%) FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20

Nasscom IT Exports 6.6 18.7 21.2 6.7 13.8 12.1 10.1 8.3 7.7 7.9 8.1

TCS 5.4 29.1 24.2 13.7 16.2 15.0 7.1 6.2 8.6 9.6 5.4

Infosys 3.0 25.7 15.8 5.8 11.5 5.6 9.1 7.4 7.4 7.6 8.3

HCL Tech 23.6 31.1 17.0 13.0 14.4 11.1 4.8 11.9 12.4 10.1 15.1

Source: Company, Edelweiss Research, Nasscom

Cloud revenue

USD bn CY15 CY16 CY17 CY18 CY19 CY20

Amazon Web Services 7.9 12.2 17.5 25.7 35.0 45.3

Microsoft Cloud Segment 23.7 25.0 27.4 32.2 39.0 48.4

Google - - 5.1 5.8 8.9 13.1

IBM 10.0 13.7 17.0 19.2 21.2 25.1

Alibaba* 0.3 0.7 1.4 2.5 4.0 6.6

Source: Company, Edelweiss Research. *9 months only.

SAP- Cloud revenues have outperformed software and licence revenues

EUR mn CY13 CY14 CY15 CY16 CY17 CY18 CY19 CY20 CAGR over

CY13-20

Software licenses and support 13,254 13,767 14,928 15,431 15,780 15,628 16,080 15,148 1.9

Cloud subscriptions and support 696 1,087 2,286 2,993 3,769 5,027 7,013 8,085 42.0

Source: Company, Edelweiss Research

6162

64 6463

6465 65

6667 67

68

7071

72

56

60

64

68

72

76

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

20

E

20

21

E

20

22

E

20

23

E

20

24

E

(%)


IT


Revenue of Salesforce and Workday

YE Jan FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20

CAGR

over

FY11-20

Salesforce 1,657 2,267 3,050 4,071 5,374 6,667 8,392 10,540 13,282 17,098 28.7%

36.8 34.6 33.5 32.0 24.1 25.9 25.6 26.0 28.7

Workday 35 111 790 1,887 1,857 1,970 1,997 2,143 2,822 3,627 54.6%


Global market share data- Indian companies gaining share

Market Share FY 05-06 FY 10-11 FY 15-16 FY 19-20

IBM 32% 26% 20% 18%

HP 12% 19% 14% 4%

Fujitsu 19% 15% 16% 14%

Accenture 11% 10% 13% 17%

CSC 10% 7% 3% 0%

DXC 0% 0% 0% 8%

Capgemini 4% 3% 4% 5%

Atos 4% 3% 4% 4%

Logica 2% 2% 0% 0%

CGI 2% 2% 3% 4%

TCS 1% 3% 6% 8%

Infosys 1% 2% 4% 5%

Wipro 1% 2% 3% 3%

HCL Tech 0% 1% 2% 3%

Cognizant 1% 2% 5% 7%

Altran 1% 1% 1% 1%

Total 100% 100% 100% 100%


IT



Trailing and implied PE (FY09-16)- Trailing PE misleading in a growth phase

TCS Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

Mkt Cap 4,86,223 14,68,405 22,81,435 22,71,648 24,74,221 42,17,729 49,86,040 47,61,342

PAT ( 1 Yr Fwd) 68,895 87,303 1,06,850 1,39,060 1,91,168 2,16,961 2,42,149 2,62,890

Implied P/E

Trailing P/E 7.1 16.8 21.4 16.3 12.9 19.4 20.6

Implied P/E at 2009 base 5.6 4.6 3.5 2.5 2.2 2.0 1.8

HCL Tech Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

Mkt Cap 82,200 2,49,926 3,11,926 2,67,984 4,32,122 8,79,472 11,28,570 11,91,904

PAT ( 1 Yr Fwd) 12,590 16,460 24,300 40,400 65,090 73,170 75,240 86,060

Implied P/E

Trailing P/E 2009 6.5 15.2 12.8 6.6 6.6 12.0 15.0


Tech Mahindra Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

Mkt Cap 31,802 1,21,159 88,347 73,036 1,19,280 4,26,225 6,11,428 5,02,807

PAT ( 1 Yr Fwd) 7,230 657 16,446 17,554 29,288 25,707 30,701 28,509

Implied P/E

Trailing P/E 2009 4.4 184.5 5.4 4.2 4.1 16.6 19.9



We firmly believe in the above equation, which we explained above, and our

confidence is based on our very detailed understanding and analysis of the entire

cloud cycle. We have vetted our above equation with several global technology

experts and have built in reasonable conservatism in it as well to avoid any big

disappointments.

In our view, investors can gain more confidence if they understand the whole value

chain of the cloud migration process right from buying access to cloud from hyper

scalers to the different tools, add-ons and security offerings which come along with

the cloud subscription. In our view, if the whole chain is understood from beginning

to end then our numbers of 16-20% growth will look reasonable and achievable.


IT


Digital revenue as % of total revenue

Infosys Wipro LTI Mindtree HCL

Q1FY18 22.6% 22.5% 29.0% -- --

Q2FY18 33.6% 24.1% 32.0% -- --

Q3FY18 26.1% 25.1% 33.0% -- --

Q4FY18 26.8% 27.3% 33.0% -- --

Q1FY19 28.4% 28.1% 34.0% 34.9% 15.6%

Q2FY19 31.0% 31.4% 37.0% 35.2% 16.0%

Q3FY19 31.5% 33.2% 37.0% 36.8% 17.1%

Q4FY19 33.8% 34.8% 38.0% 37.0% 18.9%

Q1FY20 35.7% 37.4% 39.0% 38.0% 18.8%

Q2FY20 38.3% 39.6% 40.0% 38.0% 18.3%

Q3FY20 40.6% 39.8% 41.0% 38.2% 18.2%

Q4FY20 41.9% -- 37.9% 38.5% 19.2%

Q1FY21 44.5% -- 42.0% 37.0% 20.3%

Q2FY21 47.3% -- 42.9% -- 20.9%

Q3FY21 50.1% -- 44.4% -- 22.7%


Faster adoption of digital payments

Source: Bain & Company

IT



Increase in online and digital activities

Source: We are social, Hootsuite

Global technology and business services spend

Source: Nasscom

Global technology spend shifting towards digital

Source: Nasscom


IT


What does our “Technology Ecosystem” say?

We diligently follow our set up procedure to revalidate our thesis every quarter and

we make a reasonable effort to cover all industry verticals, service segments and

geographies to find out any outliers in our thesis. The reason to run the exercise at

a quarterly interval is simple--all stakeholders generally have a reasonable clarity

(we would say almost 95% + clarity) on quarterly spends by middle of the quarter

and hence it gives us a good idea on what is happening at the ground level. We also

ensure that along with the quarterly update on technology spend, we take an update

if there is any deviation in the earlier communicated five years’ plans. We believe,

while the quarterly update is a good exercise to revalidate our thesis, we are always

more interested in five years’ technology plans of global spenders.

What is the feedback we are receiving now?

Our quarterly exercise indicates the following:

Our recent (re)interactions with the who’s who of technology spends across

geographies and verticals reinforce the Techolution thesis (link). Such interactions

over the past 45 days show technology spends are accelerating triggered by: i) higher

cloud adoption across industries/verticals/geographies; ii) substantial jump in tech

spends led by BFSI’s renewed propensity to spend also spurred by hyper activity

from fintech players; 3) sharp bounce back in manufacturing and product

engineering services; 4) retail refocusing on core infrastructure as well as digital; and

5) telecom and energy remain subdued. Also, most CTOs have shown extreme

urgency in making the first move to cloud as reflected in hyper scalers revenues.

However, the second wave of covid-19 has kept implementation slow, thereby

leading to much higher deal award activity.

We reiterate—again enthused by emerging and reassuring evidence— that the

mega technology upcycle has just gotten underway. IT companies across the board

have started acknowledging that margin improvement is more structural than they

anticipated earlier. Consensus forecasts, though, are still building in revenue growth

and margins much lower (~150bps) than what companies themselves are indicating.

This reality-consensus mismatch again raises the odds of a big outperformance in

Q4FY21 (barring the currency risk), much like the preceding three quarters, and of

10–15% quick returns by IT stocks over and above their roaring gains since May. Ride

the Upcycle.

We cite a few new data points: i) Recovery in the BFSI vertical is much stronger than

anticipated and triggered by fintech disruption. ii) Focus on cloud has taken a clear

precedence over non-cloud spends. iii) Clients across the board are increasing tech

budgets for CY21 led by additional allocations triggered by cost savings in non-

technology costs.

Most clients are allocating a higher proportion to technology spends than

previous years. Besides, their perception of the future use of technology, its

adoption and benefits has undergone a meaningful shift.

Cloud has clearly taken precedence in spends as clients now increasingly and

strongly-than-ever believe that they need agile IT infrastructure to manage

variable data loads. This view is accentuated by the pandemic-led explosion in

online activity.

Clients have seen an increase in scope of technology adoption across

departments and functions post-pandemic, implying much higher adoption of

technology.

Client spend momentum more robust than

ever

Except Telecom and Energy, feedback robust

across verticals/geographies


IT



The BFSI segment is witnessing decadal-high budgetary allocations towards

technology triggered by the urgency to integrate the servers to app ecosystems

and connecting them to cloud. This is triggering spends not only in the pure

banking industry (which has been digitalised relatively more) but more so on the

non-banking side, e.g. asset management and wealth management.

Extensive inputs from global tech experts, consultants and technocrats, not to

mention management commentaries over the past nine months, indicate the Indian

IT industry is in a sweet spot to exploit this opportunity. The following reinforce our

confidence:

1. The global sourcing market is USD200–250bn, accounting for less than 25% of

global IT services spends (excluding in-house spends).

2. The Indian IT services sector has been consistently gaining market share by 1–

2% over past several years; its share now stands at ~70%.

3. Large technology players have been gaining substantial market shares at the

cost of large MNC outsourcing players such as IBM and HP (3% to 19% over

FY05–20; refer to Exhibit 5).

4. The current pandemic with higher demand for the WFA (work from anywhere)

model has further entrenched the labour arbitrage, thereby making it virtually

impossible to compete with Indian outsourcing players.

Margins to rise; execution savings higher than incremental costs

We expect margins of key companies in our coverage to improve by 250–350bps

over the next three years over FY20 levels, and believe current consensus earnings

forecasts are still 10–25% lower, even in the base case scenario. Our thesis is based

on a detailed reckoning of every single cost component along with first-hand input

from industry veterans.

Our optimism on margins is based on the following: i) sub-contractor costs, which

have moved up substantially (5-10%) over the past five years, will continue to

witness structural downturn led by higher offshoring and higher acceptability of

WFA model; 2) stable wages at the bottom of the pyramid over more than a decade;

ii) massive physical and virtual training capabilities enabling lower skilling costs; and

iii) new paradigms of execution (work from anywhere to work from home)

containing wage inflation structurally with opening up of talent pool from tier 3-4

towns, thereby widening the labour arbitrage vis-à-vis global players and

strengthening the entry barriers that Indian players have built over the years.

Moreover, it will narrow the gap between EBITDA and EBIT margins owing to lower

capex and depreciation and substantial savings in overheads.

We also beg to differ with the unfounded theory that pricing for Indian IT companies

will come under pressure as margins improve; we argue that margins are a function

of growth above anything else.

Margins not at risk as sub-contractor cost to

fall further


IT


EBITDA margins of Indian IT companies

FY15 FY16 FY17 FY18 FY19 FY20 Q3 FY21

Infosys 27.9 27.4 27.2 27.0 25.3 24.5 28.6

TCS 26.1 28.2 27.5 26.4 27.0 26.8 29.1

HCL Tech 24.7 21.5 22.1 22.6 23.1 23.6 28.2

Tech Mahindra 18.4 16.1 14.4 15.3 18.2 15.5 19.6

Mindtree 19.9 17.5 13.5 13.6 15.2 13.7 23.1

L&T Infotech 20.2 17.5 18.9 16.3 19.9 18.7 23.2

L&T Technology Services 15.2 16.9 18.0 15.4 18.0 19.8 19.7


Our discussions with current and ex-employees of Indian tech industry indicate

structural cost advantage going forward:

The outsourcing business is fundamentally a “work from anywhere” (WFA)

model and is now becoming mainstream with rising acceptance among clients as

well as employees.

Most employees will be happy to WFH even post-lockdown as it gives them relief

from a long, polluted commute, saving sizable time that promotes work-life

balance Moreover, there is a huge untapped WFH workforce available in the

market at 10–15% lower pricing than normal and potentially lower attrition too.

Such professionals will reduce wage cost and by extension additional capex for

facilities and depreciation charges or rentals (most companies spend 100–150bp

on the latter).

A large chunk of travel related to induction, interviews, appraisals, meetings and

training will shift to the electronic mode incrementally, enabling sustained and

substantial savings in travel/hospitality costs (most companies spend about

300bps on travel-related costs).

Last, but not the least, the covid-19 pandemic will engineer a structural change

in clients’ and service providers’ mind sets to revaluate onsite workforce

requirements. This will not only save costs for clients (as onsite billing rates are

3x offshore rates), but will be also margin-accretive to service providers,

although it will entail a somewhat negative impact on revenue growth.

Substantial capex savings with increasing proportion of WFA workforce

Revenues EBIDTA EBIT Depreciation Capex EBIDTA % EBIT% Dep % Capex %

TCS 15,69,490 4,21,184 3,85,884 35,290 23,770 27% 25% 2% 2%

Infosys 9,07,910 2,22,680 1,93,740 28,940 75,690 25% 21% 3% 8%

Wipro 6,13,401 1,26,592 1,06,151 20,861 31,054 21% 17% 3% 5%

HCL Tech 7,06,780 1,66,930 1,38,530 28,400 25,121 24% 20% 4% 4%

Tech Mahindra 3,68,677 57,261 40,628 14,458 13,773 16% 11% 4% 4%

LTI 1,08,786 20,292 17,561 2,731 2,806 19% 16% 3% 3%

LTTS 56,192 11,105 9,403 1,829 1,492 20% 17% 3% 3%

Mindtree 77,643 10,623 7,869 2,754 1,253 14% 10% 4% 2%

Cyient 44,275 5,961 4,083 1,878 660 13% 9% 4% 1%

Persistent 35,658 4,929 3,270 1,660 1,512 14% 9% 5% 4%

Eclerx 14,375 3,236 2,527 709 750 23% 18% 5% 5%


IT



Positive impact on margins due to WFA and consequent savings

Margin Working Infosys TCS HCL Tech Tech M Mindtree LTI LTTS

Margin - FY20 2,130 2,460 1,960 1,100 1,010 1,610 1,650.0

Currency Tailwind ( in bps) 113 101 113 90 113 113 113.0

Travel Expense ( H1 FY21) - Savings 104 130 130 140 194 135 90.0

Increment in H2 FY21 (35) (45) (40) (40) (75) (75) (75.0)

Lockdown Overhead Saving 30 50 60 60.0

Bankruptcies/pricing/discounts - Covid 19 (100) (110) (150) (150) (110) (110) (110.0)

Margin (bps) - FY21 2,241 2,536 2,013 1,190 1,132 1,733 1,728

Margin ( %) - FY21 22.4 25.4 20.1 11.9 11.3 17.3 17.3

Currency Tailwind ( in bps) - - - - - -

Travel Expense Reversal of FY21 (78) (85) (60) (91) (126) (88) (58.5)

Increment (60) (60) (85) (50) (75) (75) (75.0)

Work from home savings 60 50 70 50 50 50 50.0

Savings in lease/depreciation due to WFH 37 40 50 40 40 40 45.0

Other overheads 90 100 100 145 285 135 145.0

Margin (bps) - FY22 2,291 2,582 2,089 1,284 1,306 1,795 1,835

Margin ( %) - FY22 22.9 25.8 20.9 12.8 13.1 18.0 18.3

Increment (60) (60) (60) (50) (75) (75) (75.0)



Other overheads 40 40 30 70 30 90 65.0

Margin (bps) - FY23 2,372 2,642 2,139 1,374 1,311 1,880 1,895

Margin ( %) - FY23 23.7 26.4 21.4 13.7 13.1 18.8 18.9

Increment (60) (50) (50) (50) (70) (70) (70.0)



Other overheads 30 37 37 57 37 37 35.0

Margin (bps) - FY24 2,443 2,706 2,206 1,461 1,363 1,932 1,935

Margin ( %) - FY24 24.4 27.1 22.1 14.6 13.6 19.3 19.3

Q3 FY21 EBIT Margin 25.4 26.6 22.9 15.9 19.6 20.6 15.2



IT


Why should you trust our Technology ecosystem feedback?

We have been regularly publishing our technology ecosystem feedback through our

quarterly notes and we have attempted to put a snapshot of our findings, our

broader inputs and compared them with actuals. The table below clearly compares

our research with actuals both qualitatively and quantitatively.

Most bullish in a decade note – 12th April 2018

What we said in our report based on inputs from our ecosystem feedback?

We visited US’ Bay Area (Ground Zero) to gain deeper insights into the deal

environment and test the veracity of our bullish call on the Indian IT sector. Our

interactions with a large sample of technologists and industry specialists convinced

us that outlook on the Indian IT sector is the "most bullish in a decade". Our

conviction is based on: i) rising number & size of digital deals; ii) recovery of spends

in BFSI, retail & utilities verticals, which contribute ~53% to Indian IT services’

revenues; and iii) front-ending of local hiring mitigating dependency on H1B visas.

Potential INR depreciation is likely to be additional margin tailwind. We reiterate our

positive stance on the sector as: a) we estimate structural acceleration in growth

rate from 6% to 10% over FY18-21; b) uptick in margins with digital gaining scale;

and c) sustenance of high cash distribution (including buy backs).

What was the stock price when we recommended?

Target Price as of 12th April, 2018

Recommendation Price (As on 12th Apr, 2018) TP (As on 12th Apr, 2018)

TCS Hold 1576 1625

Infosys Buy 586 738

HCLTech Buy 496 613

Wipro Hold 221 320

TECHM Buy 672 789

LTI Buy 1398 1750

Persistent Buy 689 1014

LTTS Buy 1194 1625

Cyient Buy 647 765

eClerx Hold 1258 1450

Source: Edelweiss Research. TCS, Infosys, HCL Tech prices adjusted for Bonus

Outcome:

Returns since 12th April, 2018

USD Rev CAGR over

FY18-20

Price on 12th April

2018 CMP

Returns since 12 April

2018

TCS 7.4% 1576 2924 85.5%

Infosys 8.0% 586 1267 116.2%

HCLTech 12.6% 496 930 87.5%

Wipro 2.3% 221 414 87.3%

TECHM 4.2% 672 936 39.3%

LTI 16.1% 1398 3608 158.1%

Persistent 3.2% 689 1687 144.8%

LTTS 16.4% 1194 2578 115.9%

Cyient 1.5% 647 652 0.8%

eClerx 0.5% 1258 936 -25.6%


https://www.edelweissresearch.com/Research/Download/1270

IT



Squeeze Up Cycle 1.0– 12th September 2019

What we said in our report based on inputs from our technology ecosystem

feedback?

Our “Squeeze-up Cycle” analysis shows the mid-cap disruption is underway; hence,

we prescribe a “model portfolio” consisting of Infosys, TCS, HCL Tech, Tech M, LTI,

LTTS, Cyient, Mindtree and eClerx, among others. We are also initiating coverage on

Mindtree with a ‘BUY’ rating and 7.5% weighting at a target price of INR824. Cyient,

Mindtree, eClerx and Persistent are trading at mouth-watering valuations and offer

an excellent entry point at present.

What was the stock price we recommended?

Target Price and Multiple as of 12th September, 2019

Price Base case multiple Target multiple Floor Price Target Price

TCS 2125 16 22 1598 2137

Infosys 816 14 20 652 923

HCL Tech 1051 12 16 1040 1360

Wipro 245 13 14 213 261

TECHM 700 10 16 615 935

LTI 1605 17 20 1816 2068

Persistent 564 12 14 638 721

LTTS 1585 18 20 1628 1821

Cyient 451 12 14 585 632

eClerx 467 10 12 720 747

Mindtree 679 15 16 757 824


Outcome

Returns since 12th September, 2019

Price (As on 12th Sep, 2019) CMP Return

TCS 2125 2924 37.6%

Infosys 816 1267 55.3%

HCLTech 526 930 77.0%

Wipro 245 414 69.0%

TECHM 700 936 33.7%

LTI 1605 3608 124.8%

Persistent 564 1687 199.1%

LTTS 1585 2578 62.6%

Cyient 451 652 44.6%

eClerx 467 936 100.4%

Mindtree 679 1634 140.6%

Source: Edelweiss Research. *HCL price adjusted for bonus

https://www.edelweissresearch.com/Research/Download/9701


IT


Techolution – World of apps – 8th June 2020


feedback?

We believe the Indian IT sector will enter a high-growth phase with stocks poised to

return20-56% upside and near-term downside risk limited to 10%. Our anti-

consensus conviction (our revenue/EPS is 2-8%/2-17% higher than Street) is much

higher now than our “Most bullish in a decade “stance two years ago and is based

on the following key arguments:

1. Recent commentaries of global 200 companies (contribute >50% revenue to

Indian tech) indicate sharp cuts in non-tech capex and higher allocation towards

technology. Past cycles indicate benefits of higher allocation flow across the

value chain and should benefit Indian outsourcers significantly. For instance,

Microsoft’s hyper growth has benefitted Mindtree immensely (Microsoft 4-year

CAGR 12.4% vs. its growth of 32.5% for Mindtree).

2. COVID-19 is a boon for technology players as it has forced exponential use of

apps and platforms, right from online shopping to e-learning to telemedicine.

This has led to a technological revolution or “Techolution” which will drive

technological spend across the value chain. The biggest beneficiary will be cloud

providers as increased data usage will accelerate migration to efficient frontier

or Cloud. For instance, Microsoft reported 61% YoY spurt in its cloud business

in the last reported quarter.

3. Digital spends will accelerate led by substantial jump in online

sales/activity/change in clients’ behaviour accentuated by COVID-19. The higher

online activity will channelise traditional marketing spends towards digital,

evident from Facebook’s results as well.

4. High growth (25-30%) in digital services to lead to further demand-supply

mismatch of talent in clients’ markets, thereby keeping pricing stable for

outsourcing players. Moreover, cost reduction initiatives owing to covid-19 (e-

travel, e-meetings, e-appraisals) will enable enterprises to restructure and re-

innovate their business substantially to keep their margins stable, excluding

currency fluctuations.

5. Substantial cash flow generation capability, higher earnings visibility,

reasonable valuation and higher ESG ranking imply significant multiple

expansion going forward.


Target price and multiple as of 8th June, 2020

CMP TM TP Dividend Total Return

Infosys 705 21 950 68 44.3%

TCS 2,053 24 2,310 146 19.6%

HCL Tech 575 16 846 49 55.7%

TECHM 580 16 798 46 45.6%

Mindtree 920 22 1,281 52 44.9%

LTI 1,856 22 2,598 109 45.8%

LTTS 1,338 20 1,872 69 45.1%



IT



Outcome

Returns since 8th June, 2020

Price (As of 8th June) TM (As of 8th June) TP (As of 8th June) CMP Returns (%)

Infosys 705 21 950 1267 79.7

TCS 2,053 24 2,310 2924 42.4

HCL Tech 575 16 846 930 61.7

TECHM 580 16 798 936 61.4

Mindtree 920 22 1,281 1634 77.6

LTI 1,856 22 2,598 3608 94.4

LTTS 1,338 20 1,872 2578 92.7



IT


Techolution – TCS - The Colossal Shines– date 26th July, 2020


feedback?

1. We believe the technology industry, after consolidating for several years, is

potentially ready for a high-growth phase led by three factors. i) The current

core infrastructure of enterprises has gasped out of capacity and can’t sustain

pandemic-led pressure of online explosion. ii) The time for trade-off between

cloud security-related concerns and growth has clearly tilted towards growth

and survival. iii) The digital upcycle has substantially elongated due to covid-19

disruption, jump in online activity and new aspects of growth such as zero-touch

becoming mainstream.

2. TCS’s, Infosys’s and Accenture’s results reinforce our confidence that the IT

industry is currently at the bottom of an upcycle. We also believe leaders such

as TCS and Infosys will gain disproportionately from this consolidation phase as

well (market share loss of CTSH and Capgemini). Our in-depth analysis of TCS’s

FY20 annual report (AR) suggests the strength of its Mission 25X25 execution

model led by Secure Borderless Workspaces (SBWS) and its sizable ~38mn hours

of training in relevant technology, both of which position it strongly to gain

further market share and cost rationalization. SBWS is a revolutionary

innovation of execution model.

3. The high cash distribution/ESG grading are additional kickers for TCS’s rerating.

We believe the best way to capture this upcycle will be to raise the target

multiple (to 27x from 24x) while earnings would follow. Maintain ‘BUY’ with a

revised TP of INR2586 (Positive on the entire sector).


The stock was trading at INR2,159 and our 12 month target price was INR2,586.

Outcome

The stock achieved our TP on 5th October i.e. within three months of

recommendation and today trades at INR2,924 up 35.4% since the above report.

https://www.edelresearch.com/showreportpdf-46620/IT_-_SECTOR_UPDATE_-JUL-20-EDEL

IT



Techolution – Wave before storm– 2nd September 2020


1. Our findings reveal a massive demand surge continues to brew led by the

explosion in online activity. A downward revision in global digital penetration

led by substantial increase in scope of applicability will further extend the high-

growth phase for digital from FY24 to FY27 at the least.

2. That structural cost savings from rising adoption of WFA on the back of

reduction in travel cost, lower wages for talent in tier 3–4 towns, lower capex

and resultant depreciation would follow are of no less significance and can

power companies on their own standing—and our realistic optimism on the

space. Squirting out of pent-up demand and GDP bounce-back are going to be

the icing on the cake.

3. We expound consensus revenue and EPS forecasts are 10–35% lower for FY22-

23E and that Indian IT stocks are trading at steep 20–60% discounts to their fair

values and 50% to global peers. In our view, this anomaly would correct over

two–three years; déjà vu FAANGs companies’?


Target price and multiple on 2nd September, 2020

Rating CMP (On 2nd Sep) TM (On 2nd Sep) TP (On 2nd Sep)

Infosys Buy 935 27 1266

TCS Buy 2246 30 2874

HCL Tech Buy 706 20 1058

Wipro Buy 272 18 322

Tech Mahindra Buy 728 20 1002

Mindtree Buy 1141 25 1460

LTI Buy 2472 25 2998

LTTS Buy 1534 22 2009

Cyient Buy 401 14 489

Eclerx Buy 693 16 1229

Persistent Buy 962 22 1344


Outcome

Returns since 2nd September, 2020

Price (On 2nd Sep) CMP Returns (%)

Infosys 935 1267 35.5

TCS 2246 2924 30.2

HCL Tech 706 930 31.7

Wipro 272 414 52.2

Tech Mahindra 728 936 28.6

Mindtree 1141 1634 43.2

LTI 2472 3608 46.0

LTTS 1534 2578 68.1

Cyient 401 652 62.6

Eclerx 693 936 35.1

Persistent 962 1687 75.4




IT


Techolution – Multiple multipliers– 6th October 2020


1. Fast-forward to FY23-27. We project digitalisation-led Techolution to drive

sector revenue/PAT CAGR of 15%/22%, with digital revenues of companies

poised to grow at >30%. The growth driver, this time around, will make up 40%

of revenue of larger players compared with a modest 15% in case of the IMS-

and Assurance Services-led rally post-GFC. We are being conservative; once the

wave rises, a tidal gush of earnings growth could unleash. Come, surf the digital

wave; it will be thrilling.

2. We believe the Indian technology services industry is at the same juncture in

terms of prospects where it was post-GFC. Then, stocks had plunged to historically

low PEs in the wake of demand uncertainty and the GFC; now, covid-19 has

wreaked a more broad-based havoc, bringing the global economy to a standstill

of sorts. Both Black Swans have stark similarities—GDP declines, job losses,

bankruptcies and swift central banks’ responses, except the current one is a

health crisis and a technology enabler, while the GFC was a financial monster.


Target price and multiple on 6th October, 2020

Rating Price (As of 6th Oct) TM (As of 6th Oct) TP (As of 6th Oct)

Infosys Buy 1112 36.0 1688

TCS Buy 2811 40.0 4000

HCL Tech Buy 857 30.0 1481

Wipro Buy 375 25.0 447

Tech Mahindra Buy 856 25.0 1253

Mindtree Buy 1517 35.0 2044

LTI Buy 2926 35.0 4197

LTTS Buy 1627 30.0 2740

Cyient Buy 385 18.0 629

Eclerx Buy 713 20.0 1536

Persistent Buy 1305 30.0 1833


Outcome

Returns since 6th October, 2020

Price (As of 6th Oct) CMP Returns (%)

Infosys 1112 1267 13.9

TCS 2811 2924 4.0

HCL Tech 857 930 8.5

Wipro 375 414 10.4


Mindtree 1517 1634 7.7

LTI 2926 3608 23.3

LTTS 1627 2578 58.5

Cyient 385 652 69.4

Eclerx 713 936 31.3

Persistent 1305 1687 29.3

Source: Edelweiss Research, Company


IT



Techolution – The Squeeze Up-Cycle 2.0– 23rd September 2020


feedback?

1. Our “Squeeze-up Cycle” analysis indicates that mid-cap disruption is behind,

except for a temporary effect of the current pandemic. Hence, mid-caps in our

coverage such as LTTS, Mindtree, Persistent, eClerx and Cyient should yield

substantial returns hereon (already up 20–100% since phase 3 began last year;

refer to September 2019 report). Our detailed analysis of select mid-size and

small-size companies in India’s technology sector—Mastek, Birlasoft, Sonata,

KPIT and Firstsource (all Not Rated)— shows they too would be the potential

beneficiaries of the upcoming tidal wave.

2. We don’t have a negative view or ‘REDUCE’ on any stock in Indian IT stocks

under coverage and strongly believe each company stands to gain from the

powerful tailwind that continues to gain heft. This sectoral tailwind will benefit

one and all—which we have been reiterating time and again through our

Techolution series (World of apps – 8th June 2020; Wave before storm – 2nd

September 2020). A substantial rub-off effect on mid-size and small-size

companies would be in order too. While mid-cap IT companies have run up 20–

100% in just one year (since we highlighted the potential upside in our

September 2019 note (The Squeeze-up Cycle), we believe substantial upside

remains aided by cost structure innovation and the high earnings sensitivity of

these companies to margins.


Target price and multiple on 23rd September, 2020

Rating Price (As on 23rd Sep) TM (As on 23rd Sep) TP (As on 23rd Sep)

Mindtree Buy 1,271 25 1460

LTTS Buy 1,665 22 2009


Persistent Buy 1,160 22 1344


Outcome

Returns since 23rd September, 2020

Price (On 23rd Sep) CMP Returns (%)

Mindtree 1,271 1634 28.6

LTTS 1,665 2578 54.8

Cyient 406 652 60.6

Persistent 1,160 1687 45.4


https://www.edelweissresearch.com/Reports/Get/B235359C-2488-43DA-ABF1-6E8DB611AFFB


IT


Techolution – On a roll – 6th December 2020


feedback?

1. Our recent (re)interactions with who’s who of technology spends across

geographies and verticals reinforce the Techolution thesis (link). Such

interactions over the past 45 days show technology spend is accelerating

triggered by: i) higher technology budget allocations than 2019; and ii) a carry-

forward of unused budget of 2020—exception to the usual zero-budget

practice. Much lower-than expected furloughs, BFSI’s renewed propensity to

spend and companies ongoing focus on technology spends stands out too.

2. We reiterate—again enthused by emerging and reassuring evidence—that the

mega technology upcycle has just gotten underway. IT companies across the

board have started acknowledging that margin improvement is structural.

Consensus forecasts, though, are still building in revenue growth and margins

much lower (~150bps) than what companies themselves are suggesting. This

reality-consensus mismatch again raises the odds of a big outperformance in

Q3FY21 (barring the currency risk), much like the preceding two quarters, and of

10–15% quick returns by IT stocks over and above their roaring gains since May.


Target price and multiple as on 6th December, 2020

Rating Price (As on 6th Dec) TM (As on 6th Dec) TP (As on 6th Dec)

TCS Buy 2,723 40 4,000

Infosys Buy 1,134 36 1,850

HCL Tech Buy 858 28 1,481

Wipro Buy 361 25 467

Tech Mahindra Buy 923 25 1,253

LTI Buy 3,267 35 4,197

LTTS Buy 1,802 30 2,740

Mindtree Buy 1,438 35 2,044

Persistent Buy 1,220 30 1,833


Eclerx Buy 781 20 1,536


Outcome

Returns since 6th December, 2020

Price (As on 6th Dec) CMP Returns (%)

TCS 2,723 2924 7.4

Infosys 1,134 1267 11.7

HCL Tech 858 930 8.4

Wipro 361 414 14.7


LTI 3,267 3608 10.4

LTTS 1,802 2578 43.1

Mindtree 1,438 1634 13.6

Persistent 1,220 1687 38.3

Cyient 479 652 36.1

Eclerx 781 936 19.8


https://www.edelweissresearch.com/Reports/Get/0568251D-8852-41B0-A879-3AD6CA0FF239


IT



Key risks to our thesis: Broadly same

Serious data breach: We believe the biggest risk to our digital surge-driven thesis

stems from any serious data breach at global tech companies primarily in the

FAANGs ecosystem. Such events may significant bring down online web traffic

and have a domino effect on technology spends owing to cautious traffic growth

outlook. In fact, any major breach event could substantially reverse investments

for a small period (say about two quarters).

Adverse currency movement: USD depreciation vis-à-vis INR and adverse cross

currency movements would modestly affect growth and earnings estimates of

the Indian technology companies.

USD/INR sensitivity to EPS of Indian IT companies

BPS Impacts/%

USD/INR Movement EPS Impact

FY20 Margins 2% 4% 6% 8% 10% 2% 4% 6% 8% 10%

Infosys 25 21.3 0.50 1.00 1.50 2.00 2.50 2.3% 4.7% 7.0% 9.4% 11.7%

TCS 20 24.6 0.40 0.80 1.20 1.60 2.00 1.6% 3.3% 4.9% 6.5% 8.1%

HCL Tech 19 19.6 0.38 0.76 1.14 1.52 1.90 1.9% 3.9% 5.8% 7.8% 9.7%

Wipro 20 18.0 0.40 0.80 1.20 1.60 2.00 2.2% 4.4% 6.7% 8.9% 11.1%

Tech Mahindra 20 11.0 0.40 0.80 1.20 1.60 2.00 3.6% 7.3% 10.9% 14.5% 18.2%

Mindtree 25 10.1 0.50 1.00 1.50 2.00 2.50 5.0% 9.9% 14.9% 19.8% 24.8%

LTI 30 16.1 0.60 1.20 1.80 2.40 3.00 3.7% 7.5% 11.2% 14.9% 18.6%

LTTS 27 16.5 0.54 1.08 1.62 2.16 2.70 3.3% 6.5% 9.8% 13.1% 16.4%

Persistent 23 9.2 0.46 0.92 1.38 1.84 2.30 5.0% 10.0% 15.0% 20.0% 25.0%

Eclerx 15 17.6 0.30 0.60 0.90 1.20 1.50 1.7% 3.4% 5.1% 6.8% 8.5%

Cyient 25 9.2 0.50 1.00 1.50 2.00 2.50 5.4% 10.9% 16.3% 21.7% 27.2%


Budgetary allocations: A substantial cut in US technology budgets, particularly

in digital, could mar the expected surge in growth at Indian IT companies.

Regulations: Any adverse regulatory provisions and visa restrictions in key client

markets may affect Indian IT companies’ capability to execute profitably.

Other risks: Some risks specific to companies (subject to their vertical

exposure/mix) are also worth a mention. They are: i) bankruptcy of a large client;

ii) delayed revival of the travel, transportation, hospitality and retail segments;

iii) loss of revenue from top client; and iv) slower-than-expected recovery in BFSI.


IT


Recommendation and valuation–All is Well (in fact better)

TCS–Total contract value


Accenture–Consulting and outsourcing revenue trends


Accenture–New bookings

Q1 19 Q2 19 Q3 19 Q4 19 Q1 20 Q2 20 Q3 20 Q4 20 Q1 21

Accenture 10.19 11.78 10.6 12.89 10.34 14.2 11.03 14.00 12.90


Infosys–Large deal signings

Q4 19 Q1 20 Q2 20 Q3 20 Q4 20 Q1 21 Q2 21 Q3 21

Infosys 1.6 2.7 2.8 1.8 1.7 1.7 3.2 7.1


4.0

5.2

6.4

7.6

8.8

10.0

Q120 Q220 Q320 Q420 Q121 Q221

(USD

bn

)

3000

3800

4600

5400

6200

7000

Q119 Q219 Q319 Q419 Q120 Q220 Q320 Q420 Q121

Outsourcing Revenue Consulting Revenue

IT



Growth of major IT companies–Jump in revenue, EBITDA and EPS CAGR

Revenue CAGR EBIDTA CAGR Earnings CAGR

CMP FY13-FY18 FY19-FY23 FY13-FY18 FY19-FY23 FY13-FY18 FY19-FY23

Microsoft 232 7.2% 11.5% 9.0% 13.9% -5.4% 12.4%

Amazon 3,093 25.6% 20.4% 47.3% 23.4% 105.6% 47.1%

Google 2,022 19.8% 8.9% 13.6% 19.4% 19.3% 13.8%

Apple 121 9.2% 6.4% 8.0% 5.4% 10.0% 5.5%

Facebook 258 51.5% 20.8% 50.3% 22.6% 71.5% 22.4%

Source: Company, Bloomberg

Edelweiss estimates–Potential huge returns even hereon



(%)

TCS

2,924

16,50,475

18,47,536

20,22,534

4,67,824

5,37,750

6,03,979

3,43,861

3,91,716

4,39,169

92

104

117

40

4,176 42.8%

Infosys

1,267

10,05,424

11,81,017

13,54,005

2,81,598

3,30,458

3,85,453

1,97,840

2,40,367

2,87,337

47

57

68

36

2,124 67.6%

HCL Tech

930

7,58,935

8,47,577

9,42,543

2,02,715

2,17,531

2,46,109

1,37,002

1,50,011

1,72,021

51

55

63

28

1,616 73.8%

Wipro

414

6,16,989

6,74,913

7,26,412

1,46,505

1,67,303

1,79,570

1,08,725

1,27,295

1,33,213

19

22

23

25

550 32.9%

Tech

Mahindra

936

3,80,777

4,15,218

4,50,514

68,432

77,886

85,298

46,035

49,782

56,071

52

56

63

25

1,450 54.9%

LTI

3,608

1,22,849

1,40,906

1,62,656

26,934

31,525

38,593

18,919

22,187

27,824

108

126

157

35

4,732 31.2%

LTTS

2,578

54,582

64,846

74,337

9,832

14,190

17,043

7,290

9,872

12,512

69

94

119

30

2,994 16.1%

Mindtree

1,634

79,667

93,585

1,05,615

16,272

19,633

22,362

10,884

13,010

15,062

66

79

91

35

2,821 72.6%

Persistent

1,687

41,944

48,025

55,109

6,566

7,676

9,656

4,261

5,155

6,353

53

64

79

30

2,166 28.4%

Cyient

652

41,294

46,078

51,762

5,916

7,201

8,428

3,637

4,618

5,398

32

41

48

18

801 22.9%

Eclerx

936

15,556

19,274

21,002

4,104

4,634

5,031

2,730

2,888

3,158

78

83

91

20

1,640 75.2%


Our findings are based on, inputs from global experts (consultants, technologists and

deal makers), and market share data spanning the past 20 years (refer to exhibit 8).

What is unmistakable is the brewing demand surge led by the explosion in online

activity. Moreover, a downward revision in digital penetration based on a realisation

of a multi-fold increase in the scope of applicability of technology during post-

pandemic re-assessment by global enterprises bolsters our confidence that the high-

growth phase would extend from FY24 earlier to FY27 in the least.

Demand surge: The power of three

1. Technology becoming mainstream: Most experts we interacted with during our

current cycle of feedback indicate that clients are clearly acknowledging rising

relevance of technology to their business than ever before. This feedback has

been unequivocal in Europe, UK and US; Asia Pacific, though, has been muted

on this front.

2. Cloud: Enterprises’ current core infrastructure has gasped out of capacity and

cannot sustain the pandemic-led online explosion. This is driving faster

migration to cloud. The time for a trade-off between cloud security-related

concerns and growth has clearly tilted towards growth and survival.

3. Digital re-scoping and adoption: The covid-19-induced disruption has greatly

elongated the digital upcycle to at least FY27 from FY24 earlier.


IT


Hence, we conclude the following:

The current change in fortunes of IT companies is more than a cycle; it is a

technology revolution or Techolution and will last at least five–seven years (until

FY27). And we are just at the beginning of the cycle.

Consensus, and even companies, would underestimate the wave and the

opportunity; they would keep upgrading estimates and target prices, respectively,

for the next few years.

Size is not a criterion to define multi-baggers; in fact, strongest players are super-

primed to yield multi-bagger returns.

We argue the obsession to unearth multi-baggers overlooking the strongest players

has not been a good idea in the technology sector, at least for the past three cycles.

For instance, TCS’s m-cap jumped 9.8x over FY09–16 on the back of CAGRs of 16%

in revenue and 25% in PAT. Similarly, HCL Tech’s m-cap surged 14.5x (CAGRs 16x and

24x). Tech Mahindra delivered 15.8x returns over FY09–16 (including Satyam

acquisition; CAGRs 22% in revenue and 17% in earnings).

Moreover, sustained market share gains by Indian players over the past several

years accentuated by leadership changes at Capgemini and Cognizant are an icing

on the cake. On the earnings front, acceptance of the WFA model has widened the

already substantial labour arbitrage--it allows to loop in cost-effective talent from

tier 3–4 towns and usually at steep discounts. Additionally, lower facility capex,

resultant depreciation and limited travel add up to momentous cost savings.

Conclusion: Rounding up our thesis; recommendations

We don’t have a negative view or ‘REDUCE’ on any stock in Indian IT under our

coverage and strongly believe that each company in the sector stands to gain from

the powerful tailwind that continues to strengthen. This tailwind will benefit one

and all—and we have been reiterating this through our Techolution series (World of

apps dated June 8; Wave before storm dated September 2; Multiple Multipliers

dated October 11).

A substantial rub-off effect on mid- and small-size companies would be in order too.

While mid-cap IT companies have run up 20–100% in just one year (since we

highlighted the potential upside in our September 2019 note The Squeeze-up Cycle),

we believe they have potential to generate substantial returns even hereon, aided

by cost structure innovation and their high earnings sensitivity to margins.






IT



Edelweiss estimates



(%)

TCS

2,924

16,50,475

18,47,536

20,22,534

4,67,824

5,37,750

6,03,979

3,43,861

3,91,716

4,39,169

92

104

117

40

4,176 42.8%

Infosys

1,267

10,05,424

11,81,017

13,54,005

2,81,598

3,30,458

3,85,453

1,97,840

2,40,367

2,87,337

47

57

68

36

2,124 67.6%

HCL Tech

930

7,58,935

8,47,577

9,42,543

2,02,715

2,17,531

2,46,109

1,37,002

1,50,011

1,72,021

51

55

63

28

1,616 73.8%

Wipro

414

6,16,989

6,74,913

7,26,412

1,46,505

1,67,303

1,79,570

1,08,725

1,27,295

1,33,213

19

22

23

25

550 32.9%

Tech

Mahindra

936

3,80,777

4,15,218

4,50,514

68,432

77,886

85,298

46,035

49,782

56,071

52

56

63

25

1,450 54.9%

LTI

3,608

1,22,849

1,40,906

1,62,656

26,934

31,525

38,593

18,919

22,187

27,824

108

126

157

35

4,732 31.2%

LTTS

2,578

54,582

64,846

74,337

9,832

14,190

17,043

7,290

9,872

12,512

69

94

119

30

2,994 16.1%

Mindtree

1,634

79,667

93,585

1,05,615

16,272

19,633

22,362

10,884

13,010

15,062

66

79

91

35

2,821 72.6%

Persistent

1,687

41,944

48,025

55,109

6,566

7,676

9,656

4,261

5,155

6,353

53

64

79

30

2,166 28.4%

Cyient

652

41,294

46,078

51,762

5,916

7,201

8,428

3,637

4,618

5,398

32

41

48

18

801 22.9%

Eclerx

936

15,556

19,274

21,002

4,104

4,634

5,031

2,730

2,888

3,158

78

83

91

20

1,640 75.2%


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March Sector Report IT Services f - Edelweiss