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Published on 10/04/2020 10:03:24 AM | Source: Motilal Oswal Financial Securities Ltd 

IT Sector - ISG shares weak outlook for traditional sourcing - Motilal Oswal

Posted in Broking Firm Views - Sector Report| #IT Sector #Sector Report #Motilal Oswal Financial Services Ltd

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ISG shares weak outlook for traditional sourcing

Expects delays in new rollouts, pricing pressure and payment deferrals ISG is one of the leading outsourcing consultants in the world working with both enterprise buyers and service providers. In its latest edition of the quarterly index call (1QCY20), ISG presented its assessment on the potential impact of COVID-19 and the trends in traditional sourcing and As-A-Service markets. Key takeaways -

 

Traditional sourcing bears bigger brunt due to COVID-19 disruption

* Overall ACV increased 7% YoY in 1QCY20. Partial COVID-19 impact dragged down growth in traditional sourcing by ~700bp to 2.2% YoY.

* As-A-Service ACV increased ~11% YoY. Weakness in SaaS was offset to an extent by the surge in IaaS as a result of Work from Home (WFH).

* Among the traditional sourcing deals, contribution of March was limited to just 15% as the COVID-19 related drop-off in core geographies started in the month.

* Despite the near full-quarter impact in certain key geographies, APAC ACV was up ~8% YoY, driven by strong increase in IaaS.

 

Expect new technology investments to be delayed by ~90 days

* ISG estimates that ~80% employees of service providers are currently on WFH and are operating at ~80% productivity (v/s previous level).

* While 60% enterprises are expected to delay new technology investments by ~90 days, 30% of the firms have cited no COVID-19 impact on new rollouts.

* ISG has also called out a trend of requests for price discounts in the range of 20%-50% across verticals for the near term (may be next 120 days). Commonly agreed upon price reduction is in the range of 20%-30%.

* Request for extension of payment terms up to 120+ days (v/s 30-60 days before COVID-19) is also being noticed across industries.

* 15%-25% cuts in discretionary spending, in areas like digital transformation, is being noticed. ISG sees this as a short term trend which may last for ~120 days.

* Sub scale and under-performing captive/data centers are expected to be monetized, creating opportunities for portfolio expansion of service providers.

 

Weak outlook for CY20, largely attributed to traditional sourcing

* Supply chain resiliency, B2C solutions should accelerate ERP & Digital solutions.

* For 2QCY20, ISG expects traditional sourcing to drop 17% QoQ and As-a-Service market to grow 5% QoQ.

* Most verticals are expected to report sharp declines (ranging from 3-45% QoQ) in 2QCY20 with Retail, CPG, Travel and Transportation being the most impacted.

* Relatively, verticals like Telecom, Media and Healthcare should be resilient.

* For CY20, while traditional sourcing is anticipated to decline 7% YoY, As-aService market should increase ~12% YoY.

 

We expect near-term uncertainty due to COVID-19; prefer INFO, HCLT and LTI

* Given the continuously evolving nature of COVID-19, we expect demand, supply, pricing and receivable uncertainties to remain in the near term.

* Negative news flow around the sector may continue given the seriousness of the COVID-19 pandemic in the core geographies like US, the UK and EU.

* In this backdrop, we expect stocks to trade below their long-time cross cycle average P/E multiples until the time this uncertainty is behind.

 

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Above views are of the author and not of the website kindly read disclaimer

* Despite the near-term uncertainty, we continue to prefer Infosys and HCLT among large caps and LTI among Tier-II companies due to their historical track record of adapting to business challenges/technological change cycles.

* Besides, we find the P/E multiples of these stocks to be meaningfully lower than their historical averages, offering adequate margin of safety.