Big domestic IT services firms may see tepid revenue growth in Q3

Both TCS and Infosys are likely to expand operating margins in Q3

Big domestic information technology (IT) services firms are likely to see tepid performance in a seasonally weak third quarter (Q3). However, operating margins are expected to expand on the back of a weak rupee and optimisation measures.

Analysts say the dollar revenues of top five firms — Tata Consultancy Services (TCS), Infosys, HCL Technologies, Wipro and Tech Mahindra — are likely to grow in the range of 1.3 per cent to 3.5 per cent in sequential terms. 

TCS is expected to report a 90 basis points (bps) improvement in the operating margins in Q3 over the previous quarter, while Infosys is likely to recoed a 70 bps sequential improvement in the margins.

“In a seasonally soft quarter, higher than usual furloughs and weakness in key verticals such as banking and financial services (BFSI) and retail will create overhang on growth,” brokerage firm Motilal Oswal said in a report. “We expect Tier-1 firms to deliver a tepid organic growth of 0-2 per cent in constant currency terms."

For the October-December period, both TCS and Infosys are expected to post weak revenue growth numbers because of lesser client spend in BFSI and retail verticals. Despite this, softness in key verticals, deal pipelines for both the firms remain decent.

“Total contract value (TCV) at TCS should benefit from the mega deal signed with the Phoenix Group. Similarly, the net-new TCV at Infosys is to likely benefit from deal wins announced with Services Australia and Telenet (during the Q3),” said ICICI Securities in a note.

For third-largest IT services firm, HCL Technologies, positive seasonality associated with the product revenue streams is likely supplement its revenue growth. The Noida-headquartered firm is likely post 1.5 per cent sequential growth in its revenues. The company, which has invested $1.8 billion for buying intellectual property assets, have already raised its constant currency revenue guidance to 15-17 per cent in FY20, against 14-16 per cent earlier. Similarly, Wipro is likely to post organic revenue growth of 1.2 per cent in Q3, ICICI Securities said.

In terms of operating margins, increased utilisation and improvement in employee mix with induction of more junior employees will support the margin profile of most large and mid-tier firms. Depreciating rupee is also likely to aid the margin profile of most companies. “The impact of these factors will offset fewer working days and delay in large deal ramp-ups in some cases,” said analysts at Motilal Oswal. 

Among mid-tier firms, L&T Infotech is expected to lead the revenue growth with 4.5 per cent sequential growth. Persistent Systems is also expected to post better earnings on higher product revenues.

"Macro factors affecting the IT industry has turned favourable in recent months, which has been indicated from Accenture results. So, the commentary of top management on deal pipeline, key verticals like BFSI and retail apart from margins will be keenly watched," said Pareekh Jain, a IT outsourcing advisor and founder of Pareekh Consulting.