IT sector Q3 preview: Deeper and longer furloughs likely to pinch largecap IT firms

Nirmal Bang analysts expect Infosys, Wipro and HCL tech to take a hit of 58 bps, 51 bps and 67 bps in margins, respectively.

We wouldn’t be chasing the recent rally,” wrote analysts at JM Financial.

Tata Consultancy Services (TCS)—the country’s largest IT company—is all set to kick off the earnings season for India Inc soon. TCS and Infosys are scheduled to report their financial results for the quarter ended December 31—a seasonally leaner period of growth for the space owing to extended holidays in the US—on January 11, and HCL Technologies and Wipro the next day.

Analysts estimate the dollar revenue of TCS and Infosys—the country’s largest and second-largest IT companies, respectively—to contract around one per cent each sequentially in Q3.

While JM Financial has pegged contraction in dollar revenue for TCS and Infosys at 1.1 per cent each on a quarter-on-quarter basis, Nimal Bang estimates it to be at 0.75 per cent and 1.45 per cent, respectively.

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The companies are entering the results season days after global IT services giant Accenture retained its full-year forecast for growth at 2-5 per cent and operating margin at 14.8-15 per cent.

Here is what else to expect from the country’s IT sector in the upcoming earnings season:

Revenues may see impact of record furloughs, weak macros, low discretionary spends

Many analysts expect record furloughs and fewer working days to impact the profitability for the IT space. “Hopes of a better second half have faded gradually. Q3 results will all but confirm that… Furloughs have likely been deeper (more clients) and longer (more days) this time… Longer furloughs and absence of budget flush are clear signs of weak demand,” JM Financial analysts wrote in a report dated January 3, 2024.

The brokerage expects large-cap IT companies to register revenue growth ranging from -2.2 per cent to 5.3 per cent in constant currency sequentially.

Nirmal Bang expects flat to negative revenue growth for Tier players and “low single digit to negative organic growth” for Tier 2 companies in constant currency. The brokerage expects Infosys to taper its top-end guidance from the earlier 1-2.5 per cent to 1-2 per cent, according to a report dated xx.

Analysts at IDBI Capital Markets add that weak macroeconomics as well as lower discretionary spending, as the US heads for a soft landing, will continue to play spoilsport.

Coverage universe of domestic brokerages
IDBI Capital	Nirmal Bang	JM Financial
TCS	TCS	TCS
Infosys	Infosys	Wipro
HCL	HCL	HCL
Wipro	Wipro	Tech Mahindra
Tech Mahindra	Tech Mahindra	LTI Mindtree
LTI Mindtree	Persistent Systems	Persistent Systems
Coforge	LTI Mindtree	Coforge
Cyient	Coforge
Sonata	Mphasis
Birlasoft
Zensar
Newgen

While Nirmal Bang expects Tata Consultancy Services' net profit to grow 3.1 per cent on a quarter-on-quarter basis in Q3, it estimates it to shrink for Infosys and Wipro, by 5.1 per cent and 3.5 per cent, respectively.

Wage hike to pinch margins?

Nirmal Bang analysts expect Infosys, Wipro and HCL tech to take a hit of 58 bps, 51 bps and 67 bps in margins, respectively.

Key monitorables

Besides, analysts will closely look out for management commentary for signs of improvement in demand conditions for the sector. “Deal trends as well as budget outlook shall be on radar as it shall give the trajectory of FY25E. In Q3, no mega deal valued at over $1 billion in terms of total combined value have been announced by IT majors, according to Nirmal Bang. “It is also possible that clients did not want any such mega deals to be disclosed; will check commentary on that front.”

Should you stay away from Indian IT on Dalal Street?

JPMorgan has a ‘neutral’ stance on Indian IT as investors await the onset of the earnings season.

The foreign brokerage has listed five themes behind its take on the IT space:

--pivot to cost saving

--declining drags from laggard industries

--pro-cyclicality

--new-term Gen AI preparatory work

--low base in CY2023

JP Morgan’s view
Stock	Rating	Previous TP	New TP
Infosys	Overweight from neutral	Rs 1400	Rs 1800
HCL	Neutral from underweight	Rs 1070	Rs 1520
TCS	Neutral from underweight	Rs 2900	Rs 3700
LTI Mindtree	Retain underweight	Rs 4100	Rs 5500
Mphasis	Neutral from Underweight	Rs 1700	Rs 2700
L&T Technology Services	Overweight from Underweight	Rs 3200	Rs 5800
Tech Mahindra	Underweight	Rs 1000	Rs 1150
Tata Elxsi	Underweight	Rs 5000	Rs 6200

After decent gains in December and elevated PE levels of Tier 1 and Tier 2 IT firms, the market is taking a view that the worst is over in this cycle and that revenue/earnings will accelerate through FY25, according to Nirmal Bang.

The Nifty IT—whose 10 constituents include TCS, Infosys, Wipro, HCL Tech, Tech Mahindra and LTIMindtree—outperformed Nifty by 210 bps in the quarter with a return of around 11.5 per cent.

IT sector performance in CY23
Stock	% performance
Infosys	1.2
HCL	37
TCS	11
LTI Mindtree	37
Mphasis	29.5
L&T Technology Services	41
Tech Mahindra	22

The brokerage maintains ‘underweight’ on the domestic IT services sector citing the likelihood of a shallow recession in 2024, which may lead to downgrades in consensus estimates for both revenue and margins and cause compression of PE multiples.

JM Financial analysts believe FY25 growth of the IT sector could fall short of Street expectations. “We wouldn’t be chasing the recent rally,” wrote analysts at JM Financial.

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