Q4 results: IT firms' revenue to get cross-currency boost, FY19 outlook key

We expect IT firms under our coverage universe to post a combined 3.1% QoQ rise in USD revenue in 4QFY18. We expect the Top-5 IT firms to post 1.9-3.5% QoQ USD revenue growth in reported terms, with Tech Mahindra to lead. Mid-sized firms will see variation, with Cyient and Mindtree likely lead (8.2%/4.1% QoQ USD revenue growth, respectively). Cross-currency movements were positive in 4QFY18, with the USD depreciating against all major currencies including the EUR (4.1% QoQ depreciation on the quarterly average rate), GBP (4.5% QoQ) and the AUD (2.4% QoQ). The INR saw slight appreciation of 0.6% QoQ vs the USD.

On the margin front we expect a positive trend almost across-the-board, as favourable currency movements, operational efficiency and automation benefits drive profitability higher. Among top-tier IT firms, we expect Wipro to post 286bps QoQ rise, albeit aided by lack of a one-time item that was expensed in 3QFY18. We expect Tech Mahindra to post 95bps QoQ margin expansion, followed by HCL Technologies (76bps), Infosys (74bps) and TCS (54bps). Within our mid cap universe, we expect Hexaware Technologies and Cyient (104bps and 96bps QoQ, respectively) to out-perform, while Mindtree (62bps), KPIT Technologies (43bps) and Persistent Systems (42bps) are also expected to post margin improvement on good revenue growth apart from cost efficiencies. YoY margin performance is likely to improve, with as many as 12 of our 14 IT coverage companies likely to post increases of 11-548bps.

We would watch for FY19 growth outlook/guidance, in context of NASSCOM’s 7-8% growth outlook for the sector, sustainable margin outlook, hiring outlook and deal flows. With the outlook for the IT sector seemingly on the mend, we would watch for acceleration in revenue growth. We believe Indian IT is a bottom-up sector and stock picks will play a key role in driving alpha.

Revenue to be steady, outlook more important

We expect 3.1% sequential revenue growth for the IT firms under our coverage universe. On a YoY basis, growth is likely to touch double digits, at 10.4%, with all except 3 of the 14 stocks under our coverage to report double digit YoY growth. This quarter, cross currencies will positively impact reported USD revenue growth, and the depreciation of the INR against the EUR (3.6% QoQ on the quarterly average rate), GBP (4%) and the AUD (1.8%) are also likely to boost the margin profile. Company-wise, we expect Tech Mahindra to lead among top-tier IT firms, while Cyient and Mindtree are likely to lead among mid-tier firms.

Margins to see improving trend

We expect IT firms to report improvements in EBIT margins in 4QFY18E, aided by currency, operational efficiency and automation. Among top-tier IT firms, Wipro (286bps QoQ) and Tech Mahindra (95bps QoQ) are likely to out-perform, while Hexaware and Cyient (104bps and 96bps, QoQ) will lead the mid-tier firms' performance. Notably, on a YoY basis, as many as 12 of the 14 IT firms under our coverage are likely to post EBIT margin expansion to the tune of 11-548bps, a key positive trend and a result of improving revenue growth and operational efficiency.

Focus on FY19E growth, margin outlook

In our view, key monitorables for the street from the 4Q results are likely to be FY19E revenue guidance/outlook, along with sustainable margin trends. Deal flows and progress on rising deal sizes of new digital deals are also critical data points to watch. Vertically, the key BFSI and Retail verticals will be watched. The increasing role of automation and other margin levers are other critical factors.

The writer is Senior Analyst - IT, Reliance Securities