This earnings season is expected to start on a muted note, with Infosys missing its organic growth guidance by a percentage point. For reasons more than one, the third quarter is expected to see Tier 1 software services majors reporting muted revenue growth (two to three per cent) on a sequential basis. For starters, the December quarter is a “seasonally slow” quarter for most players, further affected by Hurricane Sandy and consequent shutdowns. Like previous quarters, Q3 will also see TCS and HCL Technologies report sector-leading growth rates.
The Street expects TCS to grow ahead of its peers even in the December quarter and report a revenue growth of 3-3.5 per cent as it has continued to sign on new clients through 2012. HCL Tech, on the other hand, has benefited from deal ramp-ups and strong order backlogs, says Barclays. Volume growth is also expected to be in the two to three per cent band for the top four companies. Most players will see a sequential fall in margins due to pay hikes and investment in sales. JP Morgan expects margins to decline by 30 basis points (bps) sequentially for TCS on fresher intake and 50 bps for Infosys due to hike in offshore salaries. Jefferies forecasts flattish margins for Wipro. Though wage hikes were absorbed in Q2, lower growth and rupee appreciation would limit expansion. However, overall pricing environment remains stable, most analysts believe.
Now the good news. Analysts say the third quarter could mark the bottom for the sector and that 2013 could see revenue growth reviving. Though analysts expect recovery in revenue growth could start from the March 2013 quarter for most players, there is no clarity on technology budgets. One argument in favour of Indian IT majors is that American corporations cannot keep cutting budgets without taking a hit. Jefferies expects 2013 to be a better year than 2012 from a demand perspective, given the relatively stable data points coming out of the US. Analysts say more than the performance of Tier-1 players, management commentary will be critical. According to JP Morgan, indications of flat to moderately higher IT budgets will be positive for Indian IT players, as Indian IT industry continues to gain market share in total IT spending.
However, the market has moderated its expectations from the sector and this is reflected in stock prices. The sector is not out of the woods. Though there may not be a sharp downside from here, an upgrade in earnings estimate will require clear triggers and clarity on the demand scenario improving.