Valuations of Indian IT companies hit all-time low

6 May, 2008, 0020 hrs IST,Harsimran Singh, TNN

NEW DELHI: Valuations of Indian IT companies have declined to an all-time low. All top IT majors are seeing a decline in their valuation ratios, primarily price/earnings (P/E) and market cap to sales ratio on BSE.

Price to earnings ratio indicate a stock’s price in comparison to its earnings per share. A fall in the P/E ratio of a particular stock also means that investors are not expecting high future earnings (despite a booming market) from the top tier IT companies.

According to Capitaline data, since 2005 India’s largest IT company TCS has seen a decline of almost 52.5% in its P/E ratio while Infosys has seen a decline of 39.5% during the same period. In fact, Infosys P/E ratio has come down from 202.92 in fiscal 1999-2000 to 19.73 in the fiscal year ended March 31, 2008, a decline of 90.2%.

According market research firm Datamonitor’s consulting director Alok Shende, “In the long run I see the IT sector following a U-shaped curve rather than a V-shaped curve. Simply because, once the downturn in US economy subsides, we may see a sudden jump in outsourcing which may boost IT companies’ valuations. But currently there is a steep fall in the IT valuations, because despite growth in IT companies’ revenues, their market cap is falling by a greater volume.”

P/E ratios of most IT companies had risen to dizzy heights in 2000. Wipro’s P/E ratio had shot up to 514 while Satyam’s had shot to 193. Since 2002, India’s third largest outsourcing company Wipro has shed almost 55.5% in its P/E ratio – from 45.67 in March 2000 to 20.32 at present (on a 12 month trailing basis).

Satyam’s P/E ratio has also declined by 15.3% in the last five years. But interestingly, it’s the only top tier IT company whose market cap to sales ratio has risen in the last five years. On the other hand, market cap to sales ratio of Infosys declined by 41% since 2005 whilst TCS’ declined by 49.8%. Since 2000, however Infosys market cap to sales ratio has declined by a whopping 92%.

The reason behind fall in IT companies’ valuations is the loss of confidence of shareholders in very high IT earnings. Factors behind decline include dollar depreciation, rising wage costs and economic downturn in the US. Moreover, the valuations in the dotcom boom days were at very high levels and experts say that now the prices of their stocks are coming down to realistic levels.

Part of the reason is also because of the linear revenue model followed by IT companies which meant adding on thousands of employees to multiply their revenues multifold. But because of rising salaries, shortage of talent and increasing competition from other sectors, companies’ earnings have taken a hit.

The rise of the rupee by almost 14% last year is also a major factor. On an average a 1% rise in rupee hits IT companies’ profit margins by almost 35-50 basis points.

Experts predict a further downturn in valuations, if the rupee continues to rise against the dollar and US goes into a prolonged economic slowdown which may hurt IT earnings.

Says Apurva Shah, Head Research, Prabhudas Lilladher, “We expect earnings growth of IT companies to be about 18.4% in FY09 and 14.5% in FY10. IT budgets are expected to remain flat for 2008. But spending on offshore outsourcing is likely to continue, though at a muted pace.”

Contrary to Datamonitor’s views, Prabhudas Lilladher says that IT sector’s P/E valuations will come down to about 12.7 by fiscal 2010. It expects Infosys P/E to come down to about 14.1 by 2010, that of TCS may come down to about 13.4. IT companies desperately need to do some smart re-engineering and move up the value chain to stem falling valuations.

via : E.T