Brokerages not rattled by big 3 IT players' tepid Q2 performance

• TCS reported a revenue drop in Q2, while Infosys and HCL cut FY24 revenue guidance.
• Brokerages made only minor tweaks to their estimates and most of them maintained their ratings.
• Large deal wins, improving margins and better utilization rates is giving brokerages confidence in the sector.

The Indian IT sector has kicked off the Q2 earnings season on a somber note. The Big 3 tech companies – TCS, Infosys and HCL Tech painted a gloomy picture of the outlook ahead. With project rampdowns, revenue leakages and cautious clients — they have re-calibrated the revenue earnings for the entire year.

TCS reported its first ever drop in constant currency revenues in four years. Infosys and HCL trimmed their revenue guidance for FY24, while TCS does not give guidance. Infosys now expects its constant currency revenues to grow anywhere between 1-2.5% and HCL expects the same to grow by 5-6% for FY24.

Mega deal wins offer comfort: Brokerages

As expected, the IT sector stocks have fallen in the last two days, yet brokerages have only done minor tweaks to their earnings estimates and maintained their buy or add ratings. Their mega deal wins, large order books; and confidence that they will hit the upper end of their guidance is providing them cushion, they say. Few have changed their ratings on the IT stocks.

“From a long-term perspective, we believe TCS has built a resilient business model by securing multiple long-term contracts with the world’s leading brands. It has also established robust capabilities that will enable it to gain market share moving ahead,” said Axis Securities.

The ₹17,000 crore buyback TCS announced at a share price that’s premium to current its price also offers mid-term levers ahead.

Kotak Institutional Equities (KIE) also said that Infosys has won a fair share of large deals to provide some visibility for FY25 growth. It cut its FY24-26 revenue estimates by 1-2% while maintaining a buy rating. Even for HCL Tech, KIE marginally tweaked its FY24-26 revenue estimates by 0.3-0.8%.

With regards to the bad news delivered in Q2, little of it has come as a surprise. The street has been pricing in possible recession in the US and slowdown in Europe for over a year now. The IT sector gained very little or nothing from the recent bull run seen in the broader markets.

In the last month, all of Nifty’s IT index constituents lost value with the exception of LTTS. Coforge, Tech Mahindra and HCL Tech shed over 4% of their values. The Nifty IT Index itself shed around 3%.

Source: NSE

Margins present a pretty picture

In times of macro-economic headwinds, IT companies are working to improve their margins. Not only have their headcount additions waned, they are pushing for higher utilization levels, lowering subcontracting expenses and also cutting down their discretionary spends much like their clients.

TCS’ earnings before interest and tax (EBIT) margins went up quarter-on-quarter by 110 basis points to 24.3%. “We believe continued supply side tailwinds should help TCS protect and expand margins despite lower growth/mega deal ramp ups in the second half,” said a report by IIFL.

HCL Tech and Infosys maintained their operating margin guidance for the year, in spite of revenue cuts – indicating that they intend to keep up their productivity levels. HCL expects its FY24 margins at 18-19%, Infosys’ expects its annual margins to be anywhere between 20-22%.

Brokerages also back their confidence. “The 40 basis point margin (EBIT) improvement during the quarter was encouraging and indicated Infosys’ ability to manage its workforce despite the lack of an operating leverage opportunity. We now expect FY24 EBIT to go up 30bp YoY,” said a report by Motilal Oswal.

Also, all three reported reduction of attrition to around 14% recording a dramatic slip sequentially. That too offers a cushion ahead that their people costs will be under control, unlike last year.