Largecap IT stks to trade sideways for 6-9 mths: JPMorgan

There have been a lot of divergent takes in the information technology space. Many investment banks seem to think the worst is over and there would be a rapid acceleration of business traction from here. Some others are not quite so convinced at these valuation levels.

However, Manoj Singla of JPMorgan supports the first camp. He sees improvement in fundamentals, which would accelerate business moving to the end of this year. He further says technology stocks have discounted a lot of good news. However, he added, “We will probably be in a sideways trading zone for most of the large caps IT stocks in the next 6-9 months.”

On Mahindra Satyam, Singla says, “We have recently downgraded the stock after a sharp price rise. Having the stock run up so much, we are not comfortable at the current price.” He prefers MphasiS among midcap IT stock and finds it difficult to see an upside in Tech Mahindra.

Here is a verbatim transcript of the exclusive interview with Manoj Singla on CNBC-TV18. Also watch the accompanying video.

Q: IT- there has been lot of divergent takes. Some of your peer investment banks seem to think that the worst is over and we will see a rapid acceleration of business traction from here. Some others are not so convinced at these valuation levels, where do you stand at JP Morgan?

A: We do think that the fundamentals are improving and we would see some business acceleration as we move to the end of this year and into 2010. Having said that we think IT stocks are already discounting a lot of good news.

So we think we will probably be in a sideways trading zone for most of the large-caps especially over the next six to nine months. However, investors looking at a two-year horizon can still buy these stocks because as the business acceleration shows next year, you will probably see more upside from these levels.

Q: A stocks from Hyderabad that has taken everyone by surprise the way its scaled up—Mahindra Satyam, what is your call on that right now?

A: We downgraded Mahindra Satyam a couple of days ago. We have had a buy recommendation on the stock for the last three months and the stock has almost doubled from there. Even factoring in some of the optimistic scenarios for the next year, Satyam is now almost trading at same valuation as some of the other peer group including HCL Tech and Mphasis. What we are saying is that given the lot of restructuring still to be done there, one is better off holding some of the peer names which is HCL Tech.

So given that the stock has already run up so much, we are not comfortable at the current price.

Q: Is it just a valuation problem for the stock or are channel checks showing that the company is having any problems holding on to clients or getting extensions of orders?

A: What we have picked up in the last few weeks is that some of the ramp downs that we were expecting earlier are probably happening more than what we thought. So I think there is a little bit of revenue problem compared to what we expected earlier. But countering that is the fact that the cost cutting measures are proceeding ahead of plans. I don’t think there is any problem in terms of profits but clearly there is revenue ramp downs happening ahead of what we expected. So, to that extent, it could be little bit soft on the revenue side.

Q: The one stock in the large-cap space which has always traded at a significant discount to its frontline peers is HCL Tech. This quarter after the results a lot of people felt that finally the big ramp ups are happening from the big deals and it is time to close the discount with the front line pees—are you convinced?

A: If one looks at HCL Tech’s performance in the last four to five years, I think just one quarter of outperformance is not going to convince investors and analysts that this company can sustainably deliver this kind of performance. So what we need from HCL Tech is at least three to four quarters of sustainable performance of this type.

I do agree that this quarter was much ahead of most analysts expectations including ours and this is indeed coming because they have signed some big deals in the last 9-12 months which are now beginning to ramp up. I think they need to sustainably deliver this kind of performance over the next three-four quarters for the valuation gap to really close.

So what we saw was that the stock did bounce for a day after the results but then it has been a bit soft and trading sideways. We are still waiting for some more confirmation in terms of numbers before we get bullish on HCL Tech.