By: Tavaga Research
India’s IT-ITeS sector initially propelled because of the Y2K (Year 2000) bug in the early 2000s and was able to thrive on the global stage as years passed. The Covid-19 pandemic has led to the Indian IT companies move into the next phase of growth as companies (big as well as small) across the globe have started adopting newer technologies and shifting towards a digital environment.
The information technology sector was born much after India attained independence but is contributing almost 10% to India’s GDP, in comparison to the Automobile industry’s contribution of 8%.
The Indian IT industry has generated more than 4 million direct jobs till date and has been a beneficiary of a cumulative FDI inflow worth $44.91 billion for the last 20 years.
After getting hit in the first quarter of FY21 in the aftermath of the Covid-19 pandemic, India’s behemoth software companies have reported better than anticipated results with Wipro, Infosys, and TCS leading the pack.
America’s top tech stocks namely Apple Inc, Microsoft Corp, Amazon.com Inc, Alphabet Inc, and Facebook Inc, who account for 28% of the S&P 500 index and represent 25% of the index’s earnings, have shot up 50% in 2020 as compared to 7% gains for the S&P 500 index.
As the US earnings season kicks in, the tech and internet-driven stocks are expected to post strong results amidst the tectonic shift in the working pattern of lakhs of Americans, thus manifesting their superior performance during difficult times.
Performance of the Indian IT sector so far:
Driven by strong deal wins, a revival of demand, better than expected guidance, and Q1 FY21 results, the Nifty IT index has delivered a return of more than 35% in the second quarter of FY21.
Aided by the recovery in the topline revenue growth and savings in costs due to lower administrative expenses with Work From Home (WFH) becoming the ‘new normal’, Indian IT firms have reported better than anticipated expansion in the EBIT (Earnings Before Interest and Tax) margin sequentially.
6-Months Performance of the Nifty IT Index
Tata Consultancy Services (TCS)
TCS reported sequential revenue growth of 4.8% in CC (Constant Currency – exchange rates used to eliminate fluctuation effects while calculating financials) terms aided by increased technology spending by its clients and also led by the end of supply-side constraints. The strong revenue growth has further contributed to margin expansion and higher net profits.
Key Takeaways:
- In rupee terms, revenue grew by 7.2% QoQ to US$5.4 bn
- EBIT Margin increased by 2.2% YoY as a result of a decline in selling, general, and administrative (SG&A) costs
- Net Profit before taking into consideration exceptional items was reported as Rs 84.3 bn a rise of 4.9% YoY and 20.3% QoQ
- Gains in market share supported by steady deal wins contributing to an increase in Total Contract Value (TCV). New deal wins TCV rose to US$8.6 bn an increase of 34.4% YoY
- Broad-based growth across geographies and verticals (Retail and BFSI)
- Buyback of equity shares at Rs 3000 per share for a total amount of Rs 160 bn representing 1.42% of outstanding shares
Infosys
Infosys surprised the street with better than expected results and a significant rise in revenue, EBIT, and PAT (Profit After Tax). Tech giant Infosys reported revenue growth of 4% in CC terms on the backdrop of lower SG&A expenses and other factors
Key Takeaways:
- Best-ever new deal wins with large deal TCV hitting a new high of US$ 3,145 mn including the Vanguard deal
- Net Profit stood at Rs 48,450 mn, an increase of 20.6 YoY
- EBIT Margin increased 2.7% QoQ and 3.7% YoY
- Free Cash Flow (FCF) generation was strong at US$ 674 mn
Wipro
Wipro reported steady quarterly performance driven by market share gains, lower bad debt provision, and operational improvements. The BPO arm which clicked a growth of 8.1% QoQ led to Wipro registering a decent revenue growth of 2% QoQ in CC terms. The newly appointed CEO stressed focusing on growth, usage of the right talent, and simplifying the operating model while outlining the key strategic priorities.
Key Takeaways:
- Buyback of equity shares at Rs 400 per share for a total amount of Rs 95 bn representing 4.16% of outstanding shares
- Lower other income led to a fall in net profit to Rs 24,850 mn from Rs 25,526 mn from a year-ago period (Q2FY20)
Corporate actions announced by Tech behemoths
TCS Buyback
TCS Buyback price, Record Date, and Acceptance Ratio
| Buyback Type | Tender Offer |
| Buyback Offer Amount | Rs 16,000 crore |
| Buyback Offer Size | 1.42% of outstanding shares |
| Buyback Number of Shares | 5,33,33,333 |
| Buyback Price | Rs 3000/share |
| Record Date | Not announced |
Source: investorzone.in; Tender offer refers to buyback of own shares through an offer letter from shareholders
In order to take the benefit of the buyback announcement by the board of TCS, one must hold the shares of TCS in physical or demat form as on the record date (which is yet to be announced). Once the buyback opening date is announced, an investor can apply for the said corporate action. An investor will receive payments for all the accepted shares.
How to calculate profit arising out of buyback?
Illustration: An investor purchases 100 shares of TCS at the LTP (last trading price) of Rs 2757 (3,00,000/3000 = 100 shares)
| Acceptance Ratio | 33% | 50% | 75% | 100% |
| Amount invested for buyback | 275700 | 275700 | 275700 | 275700 |
| No. of Shares Buyback | 33 | 50 | 75 | 100 |
| Buyback Profit (in Rs) | 8,019 | 12,150 | 18,225 | 24,300 |
| Profit (in %) | 2.9% | 4.5% | 6.6% | 9% |
Source: investorzone.in; LTP as of 16th October 2020
Considering SEBI’s recent mandates, for retail shareholders having a holding of less than Rs 2 lakhs, the companies are legally bound to reserve 15% of the buyback to these retail shareholders. This eventually leads to an increase in the acceptance ratio for small investors. The 2018 TCS buyback witnessed an acceptance ratio of 100%. While the buyback acceptance ratio for 2020 is yet to be announced, estimates suggest that the ratio could be anywhere between 75-100% for retail investors letting them make a quick return between 6-9%.
Infosys
Infosys has announced an interim dividend of Rs 12 per equity share and fixed the record date as 26th October 2020.
Considering the cost savings on the back of the work from home model, the interim dividend rose 50% YoY.
Wipro Buyback price and Record Date
| Buyback Type | Tender Offer |
| Buyback Offer Amount | Rs 9,500 crore |
| Buyback Offer Size | 4.16% of outstanding shares |
| Buyback Number of Shares | 23,75,00,000 |
| Buyback Price | Rs 400/share |
| Record Date | Not announced |
What can go wrong with the Indian IT space?
The Covid-19 pandemic has resulted in more than 10 lakh deaths and close to 4 crore people have been affected worldwide. The impact on companies’ financials due to the lockdowns followed after the virus outbreak has been quite material. Companies worldwide have recognized the effects of the pandemic and made provisions to cover for the detrimental consequences on the asset quality and future business plans.
Financial companies in India and around the world have exercised circumspection due to regulatory oversight. Banking regulator RBI did not allow any dividend declaration for FY20 in order to conserve liquidity. Banks have not only made provisions against extraordinary losses due to the potential impact of coronavirus but also made provisions against loan moratoriums.
Indian IT companies have a substantial customer base from the US and European countries and a significant amount of revenue comes from the manufacturing, financial services, and communications sectors. Unlike the financial sector, IT companies in India have not made any provisions against under-recoveries or extraordinary losses arising out of short-term and non-current receivables from foreign firms. Instead, the IT companies have recommended mammoth buybacks and dividends.
| Company | Total Assets | Receivables | Cash & Bank Balance | Dividend/Buyback amount |
| TCS | 115,669 | 40,367 | 5443 | 16,000 |
| Infosys | 86,109 | 15,922 | 16,247 | Yet to decipher |
| Wipro | 875,215 | 119,436 | 152423 | 9500 |
Source: Company Reports; (Figures in Rs Crore)
Nifty IT ETF: A better way to invest in Nifty IT Stocks
Selecting best performing IT stocks still poses a challenge to retail investors and the sectoral/thematic mutual funds have high expense ratios, making them a high-cost product.
The average expense ratio of IT mutual fund schemes is 1.9-2.5%.
With more permissions being granted to launch new products, the Nifty IT ETF has recently gathered some traction among retail investors. The Nifty IT ETFs track the benchmark Nifty IT index which comprises of 10 stocks from the information technology sector.
Nifty IT Index Weightage
ICICI Prudential Nifty IT ETF and Nippon India Nifty IT ETF were the latest entrants in India’s passive market. These ETFs closely correspond to the benchmark and charge a relatively lower expense ratio of 0.22%.
Longer-Term IT Growth Story Intact
The majority of companies in and around India that have digital businesses set up have either maintained or increased their digital transformation budgets. Many organizations are yet to deploy essential digital capabilities. In order to reduce operating costs, build new businesses to cater to customer behavior changes, increase efficiency and productivity, and shift to new operating models, organizations are expected to spend heavily on tech integrations resulting in further growth of Indian It companies (Source: TCS Survey 2020).
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