“We expect continued weakness of India’s IT services companies (particularly in CMT vertical and discretionary revenue) to weigh on the sector’s 2QFY24F and FY24F revenue growth outlook. We believe the void created by the lower number of small-sized and discretionary projects along with delays in client decision-making and ramp-up of won projects in certain cases will lead to both revenue and margin disappointments in the near term, given the ‘sticky’ nature of costs,” Nomura’s Abhishek Bhandari said.
His analysis suggests the current slowdown to be an entire FY24 phenomenon rather than 1H and the impact possibly extending to FY25 discretionary spends.
What to expect from Q2 earnings season:
1) Revenue growth
While Nomura expects largecaps to report revenue growth ranging from -1% to +2% QoQ and midcaps to report growth ranging from +0.7% to +3.3% QoQ in constant currency (cc) terms, Jefferies expects aggregate revenues to grow by 0.5% QoQcc, marking a return to growth after two quarters of revenue decline.
“We expect Infosys (+1% QoQcc) to lead on growth, while TechM (-1% QoQcc) and Wipro (-1% QoQcc) are likely to lag. Among mid-sized firms, we expect Coforge to lead with 2.5% QoQcc growth, while growth at LTIM would be soft at 1% QoQcc,” Jefferies said.
The impact of cross-currency headwinds could be limited to 30bps.2) Deal wins
With Infosys, TCS, and HCL Tech bagging key large deals centring around cost optimization and consolidation, booking velocity has been strong in the sector.
“We expect collective deal TCV (Tier1 + Tier 2) growth to stay in line or improve sequentially vs. Q1. Q1 reported a 1% QoQ decline in deal TCV. However, with elongated ramp-up, these deals will have limited contribution in the second quarter,” Motilal Oswal said.
3) Margins
In terms of margin performance, TCS and HCL Tech are likely to outperform, while the margins of LTIMindtree and Tech Mahindra are expected to decline by 120bps and 75bps, respectively. Within mid-tier IT, Sonata Software and Persistent Systems are expected to lead growth while Zensar is expected to lag.
“Some saving graces for the industry will continue, in our view, such as easing supply side challenges through falling attrition and salary hikes returning to usual levels compared to the huge spike seen in FY23,” Nomura said.
4) Management commentary
Investor focus would be on commentary around the demand environment and any signs of improvement or expectations of recovery in 2HFY24. JM Financial expects HCL to reduce its organic services/consolidated revenue growth guidance by 2 ppt to 4.5%-6.5% and 4%-6% respectively.
“We expect Coforge to cut its guidance from 13%-16% to 12%-14%. We expect Wipro to guide for a 0-2% cc QoQ growth for 3Q. Players may however retain their margin guidance. Investors should also look for any signs of possible budget flush and indication of higher/lower impact of furloughs in 3Q,” it said.
5) Corporate action
TCS is expected to announce a share buyback programme along with its quarterly results. The Mumbai-based software exporter had last year declared a buyback worth Rs 18,000 crore, which amounted to about 1.08% of its equity share capital.
Which stocks to buy?
With most IT stocks having outperformed Nifty in the last three months and year-to-date, investors are being selective. Nifty IT’s valuation at 24x PE, which is at a 20% premium to 10-year average and 28% premium to Nifty, is rich.
Within the IT pack, Jefferies has buy ratings only on Infosys and Coforge while Nomura is bullish on Tech Mahindra, Coforge and Birlasoft.
Motilal Oswal, on the other hand, prefers Tier-I players over their Tier-II counterparts, given the former’s attractive valuations (one-year forward median 22x), payout yield (median 4.1% FY25E), and diversified business portfolios. Top picks include TCS, HCL Tech, Infosys and Cyient.
Earnings calendar:
- TCS – October 11
- Infosys, HCL Tech – Oct 12
- Wipro, LTIMindtree, Persistent Systems – Oct 18
- Coforge, Mphasis, Cyient – Oct 19
- Tech Mahindra – Oct 25
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)