scorecardresearchIT Q3 Preview: Uncertainty on demand to linger; here's what 5 brokerages expect

IT Q3 Preview: Uncertainty on demand to linger; here's what 5 brokerages expect

Updated: 03 Jan 2023, 08:09 AM IST
TL;DR.
Eyes will be on management commentary on the outlook and deal pipeline when concerns over a recession in the US and Europe prevail.
 The Nifty IT index plunged 26 percent in 2022 against a 4 percent gain in the equity benchmark Nifty50.

The Nifty IT index plunged 26 percent in 2022 against a 4 percent gain in the equity benchmark Nifty50.

While Q3 is a seasonally weak quarter, macro headwinds in the West will hit the revenue and guidance of most IT firms.

Concerns over a looming recession in the US hit Indian IT stocks hard in 2022. The Nifty IT index plunged 26 percent in 2022 against a 4 percent gain in the equity benchmark Nifty50.

Eyes will be on management commentary on the outlook and deal pipeline when concerns over a recession in the US and Europe prevail.

Let's look at what top brokerages predict about the Q3FY23 earnings of the IT sector.

Brokerage firm: Kotak Institutional Equities

The brokerage firm expects muted revenue growth of 0-3 percent for the companies under its coverage due to deteriorating macro and furloughs.

Revenue growth may moderate to high-single digits to low-teens on YoY (year-on-year) comparison. EBIT margin has bottomed out and will likely improve, albeit moderately, Kotak said.

The brokerage firm believes TCS and HCL Tech may report a relatively better quarter, while Tech Mahindra and Mphasis should lag.

"We expect investor focus on growth/decline in IT budgets for the calendar year 2023 (CY23), the state of demand, and the pace of decision-making. Infosys, HCL Tech and Mphasis are our top picks," said Kotak.

Brokerage firm: Nirmal Bang Institutional Equities

Nirmal Bang believes the Q3FY23 may be a weaker quarter than the one envisaged three months back, especially on the margin front.

"We will see a return to industry seasonality in revenue after two years of ‘compressed digital transformation’ related strength in the December quarters of 2020 and 2021. The weakness may be accentuated by company-specific disappointments due to higher furloughs (largely in BFSI and Hitech verticals)," said Nirmal Bang.

While margins will improve on a quarter-on-quarter (QoQ) basis for the entire coverage universe, the brokerage firm thinks they will disappoint vis-à-vis prior expectations.

The pressure will come from weaker-than-expected revenue growth, lower utilisation QoQ due to higher furloughs, the tail-end of wage pressures, higher travel and higher sales and marketing spends.

"While we expect QoQ CC revenue growth for players under our coverage at 1–3.5 percent and QoQ margin improvement, the investor focus is more on FY24. We remain underweight in the IT sector and prefer tier-1 set to tier-2," said Nirmal Bang.

Brokerage firm: IDBI Capital

Q3 is a seasonally weak quarter mainly due to higher furloughs. In addition, macro challenges are leading to weakness in the mortgage, luxury retail, and Hitech and a slowdown in 5G CAPEX.

In addition, European geography and discretionary spend are expected to slow down. A slowdown in the large deals, delays in decision-making, cost take-outs and vendor consolidation are other key focus areas.

"In the current quarter, we expect subdued revenues across IT companies. We expect largecaps to register dollar growth of 0.7-2.8 percent QoQ in CC terms aided by 0-10 bps cross currency. Among mid-caps we expect revenue growth of -5%-5 percent QoQ (organic) in CC aided by 0-20 bps cross currency. Tier-1 margins are expected to improve on QoQ basis in the range of 35-117 bps. We prefer Infosys among largecaps and Cyient among midcaps," said the brokerage firm.

Brokerage firm: Emkay Global Financial Services

Emkay believes revenue growth momentum will moderate in Q3 due to furloughs, fewer working days, deferred spending by few clients, and increased cautiousness among clients amid macro uncertainties.

"We expect revenue growth of 0.8-3.7 percent CC QoQ for tier-1 companies and of -0.4 percent to 3.4 percent for midcap companies," said Emkay.

"We reckon Infosys and HCL Tech will retain their guidance of 15-16 percent CC YoY revenue growth/21-22 percent EBITM and 13.5-14.5 percent CC revenue growth/18-19 percent EBITM for FY23, respectively. Wipro is expected to guide for 1-3 percent CC QoQ revenue growth for Q4," said Emkay.

Risks of recession and potential cuts in FY24 revenue remain; however, margin resilience and the weak rupee would limit earnings cuts.

"Our pecking order is Wipro, Infosys, Tech Mahindra, HCL Tech, and TCS among tier-1 players, and Zomato, Mphasis, Birlasoft, Firstsource Solutions, and Persistent Systems among midcaps," said Emkay.

Brokerage firm: Investec Securities

"We see the potential for negative surprises across the board on revenue led by higher furloughs and pressure on the existing book of business," said Investec.

The brokerage firm believes deal wins could be in line with historical trends in most cases; however, these are deals that have been in the making since Q1FY23. Q4FY23 could begin to reflect lower deal flow in our view.

Investec said the risk for IT services stocks is continued revenue weakness in the second half of FY23 (H2FY23), followed by a tepid start to FY24E. This could bring down tier-1 growth expectations to 6-7 percent versus 8 percent currently, leading to a potential contraction in P/E multiples.

"We don’t expect any changes to full-year revenue growth guidance of Infosys or HCL Tech; however, the top end of the guided range is unlikely to be achieved for both in our view. Tier-2s could see sharper revenue downgrades," said Investec.

"KPIT Technologies is likely the only standout demonstrating revenue resilience. Commentary on margins should begin to get positive, but demand commentary could get incrementally weak. Overall, the third quarter’s performance is likely to drive caution for the sector. Prefer Infosys and Persistent Systems," Investec said.

Disclaimer: The views and recommendations given in this article are those of the broking firms. These do not represent the views of MintGenie.

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First Published: 03 Jan 2023, 08:09 AM IST