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US slowdown may hit mid-cap tech valuations

The risk of a slowdown in the US and a weakening dollar may severely hit the mid-cap firms in India's IT sector, reports Arun Kumar.

business Updated: Sep 16, 2007 23:04 IST
Arun Kumar

The risk of a slowdown in the US and a weakening dollar are likely to severely hit the mid-cap companies in the country’s informational technology (IT) sector. The dollar’s depreciation has already squeezed the tech sector’s cost arbitrage advantage significantly and, experts feel, a slowdown would impact their revenues further reduce their margins.

Analysts said that mid-cap Indian IT companies have consistently lagged larger players both in terms of revenue growth and margins during cyclical upturns as well as downturns. This is due to the higher bargaining power of large players, which have more diversified service offerings and superior relationships at board levels. In the event of a US slowdown, this would lead to a higher negative impact on mid-cap Indian IT companies, they said.

Despite the fact the Sensex is at a peak level of 15,603 points, some mid-cap IT stocks are currently trading at less than 50 per cent of their 52-week high.

Companies such as Aztec Software is currently trading at Rs 72, as against the 52-week high of Rs 188. Sasken Communications, a niche player in the telecom software space, is currently trading at Rs 342 per share, as against its 52-week high of Rs 624 per share. Similarly, Polaris Software is down 52 per cent from its year’s peak level.

According to Manoj Singla of JP Morgan: “As the risk of a US slowdown increases, mid-cap players would be the first ones to feel the pinch. While we have not had enough evidence for a slowdown, we believe that even a slight uncertainty on the economic environment can be negative for the earnings of mid-cap companies.”

The expected US slowdown combined with the recent depreciation of the dollar has severely affected mid-cap companies that have a bias towards the US market, said Amitabh Chakrabarty, head of equities at Religare Securities.

In the emerging scenario, the IT sector is set witness a major consolidation in the next couple of years, said Yogesh Kapur of Enam Financial. “As the market becomes more competitive, it would be difficult for the midsize companies to establish a global presence, which is particularly crucial for de-risking country-specific slowdowns or hedging currency fluctuations,” Kapur said.

While the dollar’s weakening has also adversely affected biggies like Infosys, TCS, Wipro, Satyam and HCL Technologies, experts said that these companies could be able to retain their margins and growth due to their diversified portfolios, while their large basket of multi-million, multi-year contracts would insulate them from risk in the long term.