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Weak Client Spends To Weigh On India’s Information Technology Earnings In Third Quarter

India’s information technology (IT) sector is expected to report subdued earnings for the third quarter of financial year 2016-17. As existing clients continue to hold back their spending on technology upgradation, software exporters are likely to feel the pinch both in terms of revenue growth and profitability. In addition, the third quarter is traditionally weak for IT companies owing to fewer working days and furloughs.

An aggregate of the top eight IT companies listed on India’s stock exchanges may see muted revenue growth of 1 percent while the net profit is expected to contract marginally by 0.1 percent compared to the second quarter of this financial year, according to Bloomberg consensus estimates. The sector’s earnings before interest and taxes (EBIT) is expected to show 0.3 percent growth sequentially.

Behind The Expectations

The impact of inconsistent discretionary client spending, which dampened growth in the second quarter, is expected to extend to this quarter, according to most analysts. Sustained pricing pressures in certain verticals may adversely affect growth further. The advantage of a depreciating rupee (against the dollar) is expected to be offset by the weakening of the euro, pound and yen against the rupee. Furloughs in the industry are likely add to seasonal weakness.

HCL Technologies Ltd. and Tech Mahindra Ltd. are likely to outperform their peers in the sector. HCL Technologies is expected to benefit from its partnership to build features and functions for IBM platforms. Infrastructure Management Services will spur further growth for the company. Tech Mahindra will see consolidation of the Target Group acquisition start contributing to earnings.

Guidance Revision

In October, Infosys had cuts its annual sales growth forecast for financial year 2016-17 to 8-9 percent from 10.5-12 percent earlier in constant currency terms. Wipro projected sales of $1,916-1,955 million for the third quarter implying subdued sequential growth of 0-2 percent. In November, this was followed by National Association of Software and Services Companies (NASSCOM), which cut industry growth for financial year 2016-17 to 8-10 percent from 10-12 percent projected earlier.

Management Commentary Will Be Key

Analysts and shareholders will watch out for any indications on client budgets for 2017. This should be followed by commentary on outlook for banking and financial services which has so far seen deepest spending cuts. The impact of change in the political regime in the U.S. on businesses and how potential possible changes in visa rules can impact EBIT margins will be among other key factors to keep an eye from outlooks presented by managements.

The set up for 2017 is promising with early indications of stronger financial services spending and initial signs of integrated digital contracts but is counterbalanced by possible delays in budgeting in select verticals.
Kotak Institutional Equities Report on January 2

(The expectations have been compiled from reports by Kotak Institutional Equities, IDBI Capital, Edelweiss Securities, Phillip Capital, and Religare Institutional Research.)

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