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IT Q2 preview: Strong deal flow, traction in digital tech to drive earnings

According to ICICI Securities, Tier-1 IT companies will see revenue growth in the range of 1- 3.5 per cent in constant currency terms on a sequential basis.

IT, IT Sector
Among Tier 2, Coforge is expected to see a sharp rise in dollar revenues of 7.4 per cent quarter-on-quarter (QoQ).

The information technology (IT) companies are expected to post healthy numbers for the second quarter of the fiscal year 2020-21 (Q2FY21) owing to multiple tailwinds such as strong deal flow, traction in digital technologies, and resolution of supply-side issues as the quarter witnessed easing of Covid-19-induced lockdowns in many countries.

Further, encouraging management commentary by Accenture recently as well as HCL Tech’s mid-quarter upward revision in revenue and earnings before interest, and tax (EBIT) margin guidance, also point towards a strong performance by the IT companies. That apart, cost rationalisation, lower travel cost, cross-currency benefits, according to analysts, are also expected to drive operating margins of the companies for the quarter under review.

At the bourses, the S&P BSE Information Technology index has outperformed the market by surging 34.2 per cent during the quarter ended September 30 as compared to a 9 per cent rise in the benchmark S&P BSE Sensex, ACE Equity data show. On Monday, TCS' market capitalisation surged past the Rs10 trillion mark for the first time, making it second Indian company after Reliance Industries (RIL) to achieve this milestone.

"All companies have successfully transitioned to the ‘work-from-home’ (WFH) model – leading to business continuity and significant cost savings. While cross-currency movement will boost reported revenues, rupee appreciation will lead to a slightly negative impact on rupee revenues and margins. The overall demand commentary is expected to remain strong – however, we could see some delay in deal closures and decision making, given the upcoming US presidential elections in November," wrote Vibhor Singhal and Karan Uppal, research analysts at Phillip Capital in a sector preview note dated October 2.

According to ICICI Securities, Tier-1 IT companies will see revenue growth in the range of 1- 3.5 per cent in constant currency terms on a sequential basis. This, coupled with a cross-currency tailwind of nearly 100-140 basis points (bps) will further positively impact dollar revenue growth, the brokerage says. "HCL Tech and Infosys are expected to see dollar revenue growth of 4.8 per cent and 4.7 per cent, respectively while Tata Consultancy Services (TCS) and Wipro are expected to witness dollar revenue growth of 3.8 per cent, and 2.4 per cent, respectively," it said in an earnings preview note.

Among Tier 2, Coforge is expected to see a sharp rise in dollar revenues of 7.4 per cent quarter-on-quarter (QoQ) followed by Mindtree, which is expected to witness revenue growth of 4 per cent QoQ, the brokerage added.

What is supporting broad-based acceleration in the Indian IT sector?

According to HDFC Securities, the three enormous industry tailwinds for Indian IT which are supporting broad-based acceleration include an increase in priority for tech spend/budgets over other budgets for enterprises, compression of timelines for core IT systems transformation, cloud migration and multi-cloud interoperability, and vendor consolidation (partner-led engagements, large deal constructs).

What to expect /key things to watch out for in Q2

Progression/regression on large deals and overall deal bookings, trends in reversal/extension of temporary pricing/volume discounts (2H growth lever), outlook on large verticals such as banking, financial services and insurance (BFSI), Retail, and Consumer packaged goods (CPG) and commentary on tech spend propensity in enterprise clients are some of the key things to watch out for, notes HDFC Securities.

That apart, whether the pressure has eased in the severely affected verticals of travel, transportation, hospitality, auto, energy, etc and when demand in these verticals will normalise and whether a structural reduction in talent costs is expected in the medium term and its impact on the margins going forward are also key monitorables.

Among individual companies, HSBC expects Infosys to raise its FY21 guidance to 1-3 per cent growth (from 0-2 per cent). "No change in guidance could be a slight negative surprise for the investors in light of the recent re-rating of the sector," the brokerage says. For HCL Tech, "guidance for 3Q and 4Q is 1.5-2.5 per cent sequential growth, and we don’t expect a change in this guidance, but if management alluded to higher confidence in the upper end of the guidance, that could be a positive surprise," the brokerage says.

Things to look for in mid-caps

Nirmal Bang Securities notes that the mid-cap IT companies have seen much stronger stock returns than the large-cap names in 2QFY21. "There is an expectation of not only a significant pick-up in revenue growth but also of margin improvement. We believe that companies under our mid-cap coverage such as Mindtree and Persistent Systems will have to deliver on both the fronts. Not only that, they need to sound positive on the medium-term prospects," the brokerage said.