Thursday, 7 July 2016

IT Shares Slump On Brexit Fears, Earnings Uncertainty

The Bombay Stock Exchange's IT sub-index slumped over 1 per cent on Thursday as frontline outsourcers - HCL Tech, Tech Mahindra, Infosys and TCS - fell sharply. IT stocks have unperformed over the last one week and one month timeframes and have not participated in the rally that took the
benchmark Nifty from sub-7,000 levels in February to 8,400 earlier this week. Notably, IT stocks have underperformed despite the depreciation in the rupee.
Key factors weighing on IT stocks:
1) Frontline IT companies get around 80 per cent of their revenue from two geographies - North America (mainly US) and Europe. The slowdown in the US, which accounts for around 50 per cent of revenue for big IT companies, has adversely impacted the growth of domestic outsourcers over the last few years. Now, there's rising fear about revenue growth in Europe, following Britain's last month decision to exit from the 28-nation European Union.

2) India's frontline IT companies on an average get a quarter of their revenue from Europe. The large exposure to Europe is a source of worry because of rising macroeconomic uncertainties in the region, analysts say. According to Religare Securities, Infosys gets 23 per cent of revenue from Europe, while Tech Mahindra's exposure is the highest at 29 per cent among large-caps. TCS, India's biggest outsourcer, gets 15 per cent of its revenue from the UK, where economists have predicted a recession following Brexit. TCS' UK-based subsidiary Diligenta, which has not been performing well, could take more time to recover, analysts say.

3) The turmoil in global financial markets following Brexit has hit shares of many European banks, which are key clients for domestic IT companies. European firms hit by Brexit are likely to curtail IT budgets and cut discretionary spending, which will impact domestic IT firms.

"While it is difficult to quantify the impact on demand at this stage, we do expect client decision-making to slow down, with tech spending and new projects likely to take a backseat amid the uncertainty surrounding Brexit," said Rumit Dugar of Religare Securities.

4) The turmoil in global currency markets is another big worry for IT companies that deal with multiple currencies. Large-cap IT companies have 7-13 per cent exposure to the pound sterling, according to Religare. The sharp depreciation in the pound post Brexit will therefore hit earnings of most IT companies.

5) Caution ahead of the upcoming earnings season, set to begin with Infosys' June quarter earnings announcement on July 15, may be another reason for the correction in IT stocks. Last week, KPIT Technologies issued a warning, saying revenues may decline by 4 per cent in the June quarter. The company's warning came days after Infosys indicated that its June quarter margins may fall by 200 basis points.

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