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MOSL: TECHNOLOGY-Riding cyclical tailwinds amid structural challenges-IT Services has moats but low growth

Technology: Riding cyclical tailwinds amid structural challenges; IT Services has moats but low growth; Valuation pendulum warrants cognizance

 

• Majority revenue from repeat business, a continuous rise in the count of multi-million dollar bucket clients and high RoICs are all indicative of Indian IT's sustained competitive advantage or economic moat.
• However, we note that competitive advantage is only one of the determinants of the growth advantage. Other factors such as maturity, penetration and value migration have their implications too, fueling the thesis of Indian IT’s current range-bound growth of mid-to-high single-digits.
• As MOSL's latest Wealth Creation Study highlighted, an economic moat without high growth leads to quality traps – stocks of such companies often underperform the benchmark indices. This is what we have observed in tier-1 Indian IT. In our view, this growth thesis also makes an early case for sustained uplifted multiples for tier-2 players.
• While structural overhang remains, there is a cyclical reprieve from: [1] sanguine US macro, [2] an improvement in weak segments such as BFS and Retail, [3] pick up in some legacy deals, which were possibly confined in 2017. This, along with the two consecutive quarters of margin beat across the board, suggests that external factors are supportive and internal execution is astute.
• Increasing sizes of deals in the Digital segment tempt us to revisit the structural growth potential, but the trend toward headcount addition (plummeted in 9MFY18), NASSCOM's FY19 growth guidance and growth potential cited by CTSH/ACN keep our hopes in check for now as far as the longer term is concerned.