scorecardresearchIT sector: After mixed March quarter results, brokerages say 'stay selective';

IT sector: After mixed March quarter results, brokerages say 'stay selective'; near-term pressure remains

Updated: 01 Jun 2023, 05:05 PM IST
TL;DR.

Post the March quarter results, brokerages believe that the near-term outlook for the IT space is worsening and suggest investors 'stay selective'.

Global brokerage Jefferies pointed out that the IT sector's revenue decline in the March quarter was due to a decline in revenues from top-10 clients.

Global brokerage Jefferies pointed out that the IT sector's revenue decline in the March quarter was due to a decline in revenues from top-10 clients.

IT companies reported mixed earnings for the quarter ended March 2023. While the tier-1 firms (largecaps) delivered muted revenue growth and modest margins, tier-2 companies (mid and smallcaps) outpaced the tier-1 pack with stronger revenue growth. Post the March quarter results, brokerages believe that the near-term outlook for the IT space is worsening and suggest investors 'stay selective'.

In a recent note, global brokerage Jefferies pointed out that the IT sector's revenue decline in the March quarter was due to a decline in revenues from top-10 clients.

"During 4QFY23, Indian IT firms witnessed a 1 percent QoQ decline in US$ revenues — the first revenue decline in 11 quarters. This was driven by a 3 percent QoQ decline in US$ revenues from their Top-10 clients. Revenues from clients outside the Top 10 were flat QoQ," it said

However, it also noted that while the aggregate revenue outlook of top clients YTD has not changed, the profit outlook has worsened, suggesting that client profitability is the key determinant of IT spending.

"While CY23/24 revenue estimates of clients have held up in YTD, profitability pressures on clients persist. Aggregate CY23/24 PAT margins for top clients of IT firms have been revised downward by 25-40bps YTD. Furthermore, barring HCL Tech, aggregate CY23 PAT margin estimates for clients of all firms have seen cuts, with the steepest cuts for Infosys, followed by TechM, Wipro, and TCS," it highlighted.

Meanwhile, brokerage house HDFC Securities also pointed out that the macro challenges are manifesting into a set of outcomes for the IT sector ranging from cuts in discretionary spending, delay in decision making (slower conversion from pipeline to TCV), slower deal ramp-up, to change in the propensity for price increases/volume discounts.

The brokerage observed that mid-tier IT can sustain its growth premium over tier-1 IT. It also highlighted that Tech Mahindra, Infosys and Mphasis have a higher risk of large clients moderating their tech spend and TCS/HCL Tech may outperform Infosys/Tech Mahindra.

HDFC believes that the risk to guidance mid-point of Infosys and HCL Tech is low, based on relative premium to global peers and the enterprise scorecard. It added that downside risk is more near-term rather than medium-term.

Among verticals, the brokerage stated that healthcare vertical trends are positive and key positive call-outs are HCL Tech and Persistent, whereas the energy & utilities vertical may exhibit incremental weakness with greater thrust on cost optimization due to enterprise growth deceleration and on centralization of functions in large spending pools.

Similarly, the telecom & media vertical also appears weak incrementally on large cost savings programs by enterprises as well as capex trending lower ahead; negative call-outs in the vertical are Tech Mahindra and Infosys, it said, adding that strong business activity across sub-segments is supporting the travel & hospitality vertical and positive call-outs are LTIMindtree and Sonata Software.

It continues to prefer LTIMindtree within large-cap IT, and Persistent Systems within mid-cap IT, with Zensar moving up in the pecking order.

Article
Source: HDFC Sec

Meanwhile, Jefferies believes that given steep cuts to both CY23 revenue and margin estimates for clients of Infosys, TechM, and Wipro, the near-term demand outlook for these companies could be under pressure. Also, given the weak positioning of top clients in Communication, Tech, and BFSI verticals, Coforge, TechM, Wipro, LTIM, and TCS have higher exposure. Combining the above, TechM and Wipro seem to have the weakest growth outlook, it added.

However, a comparison of the change in revenue growth expectations for IT firms and their top clients in FY24/CY23 vs FY23/CY22 suggests that Coforge, Wipro, and LTIM are at a greater risk of negative surprises on FY24 growth, noted the brokerage.

Article
What is EBITDA
First Published: 01 Jun 2023, 05:05 PM IST