TCS, Infosys, HCL Tech amongst top picks of analysts heading into the Q4 earnings season

• India’s bellwether IT companies TCS and Infosys are all set to kick off the Q4 earnings season next week.
  
• Deal pipelines have also remained intact, but cautiousness amongst clients has caused delays in conversions.
  
• The consensus is Tier 1 IT companies like TCS, Infosys and HCL Tech are best placed to take advantage of the near-term caution amongst clients.
  

India’s bellwether IT companies TCS and Infosys are all set to kick off the Q4 earnings season next week. Along with other Tier 1 IT companies, they have emerged as the top picks of analysts even as the IT sector is looking at a weak quarter amidst worsening macroeconomic conditions in key markets of the US and Europe.

Management commentary from IT giants TCS and Infosys during the Q3 earnings underlined slowdown concerns, especially in the US and Europe. The recent banking sector crisis in these two markets is expected to have a near-term impact on spendings by banks.

While Indian IT companies have little exposure to the crisis-hit regional banks in the US, their clients in the banking, financial services and insurance (BFSI) are likely to be impacted. The BFSI sector forms a large part of Indian IT companies’ revenue, and it could be marginally impacted.

“Though the Indian IT services firms do not have meaningful exposure to the affected US regional banks, fears of a banking crisis could impact near-term IT spending by banks,” said a report by Motilal Oswal.

TCS and Infosys emerge top picks

Coupled with the focus of clients on vendor consolidation and cost optimization, Tier 1 IT companies are best placed to take advantage when compared to their Tier 2 peers.

“We continue to prefer Tier-I players over Tier-II companies, given the former’s attractive valuations, increased traction in vendor consolidation and diversified client portfolios,” the brokerage added, saying that it expects TCS to benefit from clients’ focus on cost optimisation, Infosys to benefit thanks to strong deal wins and HCL Technologies to benefit from increasing cloud adoption.

Overall, the brokerage expects the Indian IT services industry to report topline growth of 9.2% year-on-year in constant currency (CC) terms in Q4. Analysts also expect the moderation in the US dollar against other major currencies to act as tailwinds and bump up the constant currency growth in this period by 60-130 basis points.


Source: Motilal Oswal

Cautious clients leading to delays in deal conversion

Management commentary in Q3 underlined that there have been delays in decision-making by clients, and that is expected to continue in Q4 as well.

“Deal pipelines have not shrunk, but conversion to new deal wins is taking longer time. Also, in certain cases, conversion of orderbook to revenues in terms of deal ramp-ups is taking longer than usual,” analysts at ICICI Securities said, adding that these delays will likely push demand to the second half of FY24 and in some cases, even FY25.

Near-term weakness is expected to spill over into FY24 as well. Analysts at ICICI Securities expect it to result in a 5% reduction in earnings per share in FY24 as well. This is assuming that there is no further escalation in the banking crisis.

Weak Q4, all eyes on FY24

The analyst consensus is that while Q4 will be a weak quarter for Indian IT companies, all eyes are now on FY24.

“We see Q4 numbers to be of little relevance,” said a report by JM Financial, adding that the focus is now on Infosys’ FY24 guidance – it expects the company to guide for 6-8% CC revenue growth in FY24, slightly below market expectations of 8-9% growth.

Analysts at Kotak Institutional Equities echoed the preference for Tier 1 companies, stating that the outlook for companies like TCS and Infosys is better when compared to other smaller players.

“The gap between leaders and laggards will widen in FY2024. Among Tier 1, TCS and Infosys offer a full suite of services, robust delivery and excellence in multiple digital competencies,” said a report by Kotak Institutional Equities.

The recent correction in the stocks of Indian IT companies has also factored in weak growth in Q4, making their valuations attractive, according to the brokerage.

The growth expectations are still intact over the longer term, though. “The secular multi-year technology upgrade cycle is expected to continue to drive demand over the medium term,” said a report by HDFC Securities.

Overall, the broader analyst consensus is bullish on the Indian IT sector in the medium to long-term, with Tier 1 IT companies being well-positioned to take advantage of near-term slowdown concerns.

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