Deal wins, demand growth to sustain L&T IT twins' outperformance

Two information technology (IT) services stocks from the L&T stable - L&T Infotech and L&T Technology Services - are riding high, even as the sector is coming to grips with a gradual rebound in demand from global clients and the Street remains cautiously optimistic.

Given the strong outlook of the two companies, both stocks have nearly doubled over the previous six months and outperformed their peers as well as the IT sector by a mile. While Larsen & Toubro (L&T) has an 89 per cent stake in L&T Technology Services, which offers engineering research and development (R&D) services, it has an 84 per cent in L&T Infotech, an IT services company with presence across verticals.

Growing at a fast pace

One of reasons for the recent uptick in the stocks has been brokerage upgrades after strong December quarter results. While most large and mid-cap IT companies are dealing with lower growth, the L&T IT twins posted sequential revenue growth of 8.4 per cent, and this was broad based. Most analysts have raised their earnings estimates for the two companies by up to 3 per cent for the next couple of years on the back of expectations of sustained growth rates.

HDFC Securities' analysts Apurva Prasad and Amit Chandra identified three reasons for L&T Technology's growth prospects. The first was client mining with a marquee base of customers, which included 48 of the top 100 global engineering R&D companies. The second reason was the strong deal momentum. Robust deal wins, which included contracts such as the aerospace deal of $50 million, and a diversified mix across sectors should aid revenue growth for L&T Technology. Finally, a recovery in the process industry vertical, which accounted for about 13 per cent of revenues after a prolonged slump, was expected to add to the company's growing revenues. 

For L&T Infotech, India's sixth largest IT services company with expected revenues of $1 billion-plus in 2017-18, the revenue uptick will come from the ramping up of large deals as well as incremental orders from digital contracts. The company's client additions in the December quarter have been among the highest in recent quarters. While banking and financial services - its largest vertical, accounting for just over a quarter of revenues - is expected to grow at a robust pace. High-tech, retail and pharmaceuticals are the other verticals that should help it to outperform peers. The company has issued a guidance for growth in the mid-teens in 2017-18 and is positive on the 2018-19 outlook, given its deal pipeline as well as demand outlook across verticals.

Analysts at Antique Stock Broking said given strong execution in the last few quarters, the company was on track for industry-leading double-digit dollar revenue growth of 16.2 per cent in 2017-18 and 15.8 per cent in 2018-19.

Premium valuations

After the stock saw a strong run-up on the bourses, both firms have traded at premium valuations to the sector at 16-18 times their 2018-19 earnings estimates. These could sustain. 

Analysts at Citi said companies such as L&T Infotech merited premium multiples, given their superior performance in a sector where growth had been slowing down and companies were finding it difficult to manage growth and margins. Investors could consider both the stocks on dips.

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