Citigroup - India IT Services

Citigroup in their report on IT Services,

Disappointing quarter; INR impact — 1QFY08 results will witness the impact of sharp rupee appreciation, wage increases (for some companies) and visa costs. We expect this to result in sharp margin decline (~350-400 bps qoq for companies with wage hikes). Our 1Q numbers are based on Rs.41/$ assumption.

Look beyond 1Q; risk reward favorable — With a ~15% underperformance against the BSE Sensex, we believe that currency-related negatives are largely priced in. Business momentum continues to be strong with pricing on an uptrend; reasonable valuations provide a good entry point for long-term investors.

2Q/3Q best in terms of price performance — Historical data (last 5 years) suggests that 2Q and 3Q are best in terms of stock price performance. We believe this is due to increased confidence in annual guidance post 1Q results and seasonally strong 2Q results and subsequent upgrades.

Will companies revise guidance downwards? — The rupee has appreciated by 4- 6% after the FY08 guidance issued by Infosys and Satyam, respectively. We expected $-term revenue guidance to be revised upwards but do not rule out a downward revision in EPS guidance.

Infosys/TCS are our top picks — We believe Infosys/TCS are best placed in terms of margin levers. With low expectations and good business momentum, HCL Tech could spring a positive surprise.