December quarter likely to be a weak one for the IT sector – Infosys amongst top analyst picks

• IT major Tata Consultancy Services (TCS) is set to kick off the December-quarter earnings season on January 9.
• Analysts believe the IT services sector is staring at muted revenue growth due to Q3 being a seasonally weak quarter.
• During the December quarter, the Nifty IT index rose 7.3%, outperforming the benchmark Nifty50’s 5.9% rise during the period.
• Brokerages maintained their bullishness on Infosys in the large-cap segment, stating that the company is likely to retain its full-year revenue growth guidance of 15-16%.

As India’s largest IT company, Tata Consultancy Services (TCS) gets ready to kick off the earnings season on January 9, analysts suggest the IT services sector is staring at muted revenue growth in the third quarter on account of it being a seasonally weak quarter.

While Tier 1 companies like TCS, Infosys and Wipro are expected to see a quarter-on-quarter revenue growth of 0.7-2.8% in constant currency terms, smaller companies like LTIMindtree are projected to report revenue growth of 2.5%.

“Q3 is a seasonally weak quarter mainly due to higher furloughs. In addition, macro challenges are leading to weakness in mortgage, luxury retail, high-tech and slowdown in 5G capex,” said a report by IDBI Capital.

Furlough is a leave of absence from work for which the employee is not paid.

IT companies had warned of weakness in certain pockets, like discretionary spendings in sectors like banking and financial services, alongwith high-tech. Infosys had underlined it in its previous quarter earnings, but said it was “ready for all types of client work”.

“The commentary on Europe was mixed as Infosys and Tech Mahindra are witnessing signs of softness in IT spends as clients are getting incrementally cautious. However, LTI-Mindtree and Wipro are still seeing tailwinds in Europe with no sign of any slowdown,” said a report by Motilal Oswal.

During the December quarter, the Nifty IT index rose 7.3% – outperforming the benchmark Nifty50’s 5.9% rise during the period – aided by favorable macros and a more-or-less unchanged demand pipeline with US markets continuing to be strong. Here’s how the top five IT companies’ stocks have performed in the December quarter:


Source: NSE

According to the analysts at Investec Bank, Tier 1 IT companies could see growth in the range of 6-7%, down from 8% currently. “We don’t expect any changes to full-year revenue growth guidance of Infosys or HCL Technologies; however, the top end of the guided range is unlikely to be achieved for both in our view. Tier-2’s could see sharper revenue downgrades,” the bank said in its latest report.

"IT stocks are at a crossroads. Valuations have declined appreciably, but yet appear to be fair, given the risk of demand slowdown. The saviors— cost take-out deals and margin tailwind from rupee depreciation—have not kicked in yet to the full extent. Declining growth and tepid TCV numbers do not paint a pretty picture," said a report by Kotak Institutional Equities.

Margin and supply-side pressures easing

The consensus among brokerages seems to be that margin pressures should ease for most companies, but that is more due to the depreciation of rupee against the US dollar and other currencies, apart from easing supply-side pressures.

For context, the rupee depreciated 1.36% against the US dollar and 10.8% against the euro during the December quarter.

However, it might still not be enough, say analysts.

“While margins will improve on a QoQ basis for the entire coverage universe, we think they will disappoint vis-à-vis prior expectations. One had expected a stronger margin performance due to lack of material cross-currency headwinds in the quarter (unlike the previous two quarters), 3% QoQ depreciation of INR vs USD and operating leverage (as salary impact was largely behind),” said a report by Nirmal Bang.

IT spending growth could slow down after two years of spending by companies, and the earnings visibility might not be as clear, according to Kotak Institutional Equities. Further, deals which have been in the works for multiple quarters now might take a while longer as clients reevaluate their spendings and budgets.

Brokerages bullish on Infosys – here’s what to watch out for

Brokerages, however, remain bullish on Infosys in the large-cap segment, stating that the company is likely to retain its full-year revenue growth guidance of 15-16%.

“We prefer companies with a good breadth of capabilities capable of addressing both run and change spends of clients, solid execution track record and available at reasonable valuations. Infosys and HCL Tech fit our thesis and remain our top picks,” said a report by Kotak Institutional Equities.

Key amongst the things to watch out for during the quarter would be the deal wins, margin outlook, and the commentary on telecom, retail and high-tech verticals.


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