Zylog Systems, Infinite Computer, Omnitech Info, Polaris, Spanco may beat Infosys, Wipro, TCS in Q1 earnings

Infinite Computer, Omnitech Info, Polaris, Spanco may beat Infosys, Wipro, TCS in Q1 earnings
6 Jul, 2011, 0950 hrs IST, ET Bureau

MUMBAI: Shares of small- and mid-cap software companies such as Infinite Computer Solutions Omnitech Infosolutions, Polaris Software, Spanco and Zylog Systems are likely to rise over 25% from here as valuations are cheaper than their larger peers and these companies are well-positioned to manage pressure on earnings, said credit rating agency Crisil.


"Currently, the valuation discount for small and mid-cap stocks compared to large-cap stocks is high at 65% vis-Ã -vis 45% in FY07 and 20% in FY08," said Tarun Bhatia, director - capital markets, Crisil Research, "We believe that IT companies under Crisil coverage should register strong volume and stable earnings growth, and expect valuation discount to narrow during the current financial year," he said in a press release.


At a one-year forward price to earnings ratio of less than 4 times, the risk-reward ratio of these companies appears favourable compared to large caps, which are trading at 15-19 times, the release said.


So far in 2011, the CNX IT Index dipped 10.8% compared with Nifty's decline of 8.3% in the period. Small- cap software stocks dropped 18.5% since January.


Analysts said second quarter earnings will play a big role in investors deciding on their investments in the information technology sector. Investors will look for the impact of macroeconomic deterioration on the demand and outlook of Indian IT companies, shifting of client spending priorities toward discretionary spending, positive pricing momentum and the impact of an increase in the number of visa rejections on revenue growth and margins in the upcoming quarter earnings, said Nomura, in a client note.


Brokerages expect revenue growth of 2-8% q-o-q across tier-1 companies while margins would be impacted by wage inflation, with the exception of HCL Tech. The margins in Infosys are expected to decline by 250 bps q-o-q on account of wage hikes, but this will be lower than management guidance of 300bps.


Standard Chartered, in its results preview report, said additions to the active client base and deals in excess of $50 million would be critical to potential volume out performance. Also, the second quarter guidance for Infosys and Wipro will be critical to guage the progress on restructuring, it said.


Nomura said earnings upgrades and the extent of pricing power will be positive triggers for software stocks. "Upgrades in revenue growth guidance at Infosys and Cognizant and continuation of pricing power momentum could be positive triggers for stocks.


In-line revenues and guidance at Infosys will be taken positively, while in-line results at TCS may not provide enough ammunition to sustain the stock price," Nomura said, rating Infosys followed by HCL Technologies as its top buys.


"We think Cognizant's future performance may disappoint, while at TCS valuations leave limited room for upside. Wipro is our least preferred stock, as results of its restructuring may take time to fructify," said Nomura.