Equity analyst Andrew Lange shares his views on three stocks in India’s infotech sector. All three have a Narrow Economic Moat rating.
The Morningstar Economic Moat Rating represents a company's sustainable competitive advantage. A company with an economic moat can fend off competition and earn high returns on capital for many years to come.
A company whose competitive advantages we expect to last more than 20 years has a wide moat; one that can fend off their rivals for 10 years has a narrow moat; while a firm with either no advantage or one that we think will quickly dissipate has no moat.
Infosys
Fair Value Estimate of $8.80 per share (Rs 620) and narrow economic moat rating.
Infosys’ narrow economic moat results from high switching costs (roughly 96%-98% of revenue is from repeat business and has been around these levels for many years). The company’s commitment to building lasting relationships, embedded systems and processes, and intimate knowledge of clients’ IT infrastructure means customers are averse to switching between vendors. On a gross basis, Infosys continually adds over 200 clients per year, which is an encouraging sign and cements further long-dated business given switching costs. Such switching costs ensure a certain level of operational consistency and the company’s exemplary financial health reflects this. We forecast Infosys to easily generate a return on invested capital in excess of its cost of capital for the foreseeable future, and we believe its lower-cost offshore delivery model allows for this assumption.
Wipro
Fair Value Estimate of $3.85 per share (Rs 273) and narrow economic moat rating.
High switching costs underlie Wipro's narrow economic moat. The company has decades of industry experience and a trove of loyal customers that rely on the firm to provide mission-critical business processes and IT services. Such mission-critical services allow for a deep understanding of clients' intricacies, and as a result, customers are reluctant to switch between vendors, as it could cause significant business disruption. Notably, Wipro's revenue from repeat business traditionally hovers around 97%-99%, supporting our view that the firm benefits from high switching costs. The firm's broad global delivery capabilities, combined with its ability to offer myriad integrated services (such as BPO services, application services, and infrastructure services), set it apart from smaller rivals and help the company attract marquee global clients. In fact, Wipro has more than 1,300 global clients, of which 150 are Fortune 500 companies.
TCS
Fair Value Estimate of $23 per share (Rs 1,635) and narrow economic moat rating.
TCS has a narrow economic moat as a result of meaningful switching costs. The company is focused on establishing and fostering deep customer relationships that provide it with long-dated and consistent business. Once established within a client, TCS’ end-to-end services portfolio and ubiquitous global presence allow it to cross-sell and develop deeper roots with clients. At the end of fiscal 2017, TCS had expanded its $1 million-plus client base to more than 1,900 from roughly 360 in 2005, which demonstrates its ability to attract and expand within large clients. In addition, we estimate group revenue from repeat business to be in the high 90s. This high rate of repeat business exemplifies clients’ reluctance to switch between IT service vendors as established end-to-end vendors become more intertwined in its customers' central IT operations. Still, we are reluctant to assign TCS a wide economic moat, given the firm’s use of an industrial model that leverages a largely junior workforce, which often relies on scale to be competitive. In addition, TCS lacks a strong consulting practice and faces competitive threats in service areas such as business process outsourcing and application development and maintenance.
