IT Sector Preview: Cross currency to affect reported dollar revenue

Key things to monitor for the street from the Q1 results is likely to be the share of digital

The IT firms under our coverage universe are expected to post a combined 0.8% quarter-on-quarter (QoQ) rise in dollar revenue in the first quarter of financial year 2018-19 (Q1 FY19). Reported dollar revenue is likely to be adversely affected owing to the strengthening Dollar against major cross-currencies including euro, pound and Australian Dollar (2-4% QoQ). We expect 40-120 bps adverse impact of cross-currencies in Q1 FY19. The top-5 IT firms are likely to post -2% to +2% QoQ dollar revenue growth, with TCS likely to lead the pack. Mid-sized firms will see variation, with Hexaware Technologies and Persistent Systems (3.7% and 3.6% QoQ dollar revenue growth, respectively). However, Cyient (0.3% QoQ) will underperform owing to seasonally weak DLM revenue. In rupee terms, revenue growth is likely to come in at 1.8-6% QoQ owing to rupee depreciation of 4.2% QoQ.

On the margin front, a largely downward trend is expected led by wage hikes. Among top-tier IT firms, we expect Wipro to post 121 bps QoQ margin expansion aided by currency and operational efficiency. We expect TCS/Infosys to report margin declines of 140bps/185bps QoQ, respectively, while we forecast 129bps QoQ margin decline for Tech Mahindra. Within mid-cap stocks, we expect Hexaware Technologies and Persistent Systems (147bps and 168bps QoQ, respectively) to outperform. 

Watch out for FY19 growth outlook/guidance, digital growth, increasing digital deal sizes, digital proportion in context of Accenture’s impressive growth, sustainable margin outlook, deal flows and outlook for key verticals including BFSI, retail and telecommunications. Return of cash to shareholders is a theme that continues to play out, with TCS, Infosys, Wipro, HCL Tech, Hexaware, Mindtree and eClerx all resorting to share buy backs in the past year to make better usage of their cash balances. 

Reported dollar revenue to be ‘crossed’ by currency, digital component key

We expect -0.9% to +3.2% sequential constant currency revenue growth for top-IT firms in Q1 FY19. Overall, dollar revenue growth is likely to come in at 0.8% QoQ, with an adverse cross-currency impact of 40-120bps likely. YoY growth is likely to come in at 8.3% at an aggregate level. Individually, 8 of the 14 stocks under our coverage are likely to report double digit year-on year (YoY) growth. Company-wise, we expect TCS to lead revenue growth among top-tier IT firms, while Hexaware and Persistent are likely to lead among mid-tier firms.

Margins to trend lower on wage hikes

We expect IT firms to report largely lower sequential EBIT margin in Q1 FY19E led by wage hikes and business investments. Among top-tier firms, we expect TCS/Infosys to report margin declines of 140bps/185bps QoQ, respectively, while we forecast 129bps QoQ margin decline for Tech Mahindra. Within mid-caps, we expect Hexaware and Persistent (147bps and 168bps QoQ, respectively) to out-perform. On a YoY basis, we expect 9 of our 14 IT coverage companies to post increases to the tune of 60-820bps. 

Focus on digital and key vertical outlook

In our view, key monitorables for the street from the 1Q results are likely to be digital proportion, given Accenture’s stellar performance led by this segment, apart from the outlook for key verticals including BFSI, Retail and Telecommunications. Apart from this, improving FY19E outlook, deal flows and rising deal sizes of new digital deals are critical data points to watch.

Harit Shah is research analyst –IT at  Reliance Securities