India’s biggest software services exporters may report a rise in revenue for the second straight quarter, aided by large deal wins and digital transformation as the economy tries to turn around from a pandemic-induced recession.
Analysts estimates compiled by Bloomberg pegged the aggregate revenue of the five information technology companies on the Nifty 50 — Tata Consultancy Services Ltd., Infosys Ltd., HCL Technologies Ltd., Wipro Ltd., and Tech Mahindra Ltd. — to increase 2.46% sequentially in the October-December period. Cumulative net profit is expected to rise 6% over the preceding three months.
That’s in line with Nomura’s estimate of a 2.6% quarter-on-quarter aggregate revenue growth in constant currency for tier-1 IT companies. “We expect 20-40 basis points from cross-currency for tier-1 IT and 20 basis points benefit for mid caps, led by appreciation in all major currencies against the U.S. dollar,” Rishit Parikh, an analyst at Nomura, said in a note.
The optimism stems from Accenture Plc’s move to raise its revenue growth guidance for FY21 to 4-6% from 2-5% earlier, and improving demand outlook. The information technology companies were among the worst hit after the pandemic stalled trade and forced employees to work from work, raising costs. The firms even lost billings as they generate most of their business overseas and the bulk of it comes from clients in financial services, manufacturing and communications sectors. The sector, however, rebounded in the second quarter, aided by large deal wins and client spending on cloud computing, artificial intelligence and internet of things.
TCS will kick-start the third-quarter earnings season on Jan. 8, 2021.
Deal Pipeline
Seven of the 10 large deals took place in the third quarter.
“We expect large deal win announcements to continue in H1 CY21 (first half of calendar year 2021) as such deals have an elongated decision-making cycle,” CLSA’s Pankaj Kapur said in a sectoral preview note.
According to Nomura, the deal pipeline has been healthy across the sector, led by demand in areas of cost takeouts—a process that redesigns fundamental elements of a business to the lowest cost structure—digital transformation including infra/apps modernisation, customer experience, cybersecurity and vendor consolidation. “However, conversion is key, especially in case of large deals.”
Guidance
Infosys after its second-quarter results had raised revenue growth guidance to 2-3% for the entire fiscal compared with 0-2% forecast earlier. It also expects to post operating margin in the range of 23-24% against 21-23% predicted earlier.
HCL Tech, too, guided its EBIT margin to be between 20% and 21% against 19.5-20.5% forecast earlier. But it maintained revenue growth guidance for the next two quarters of FY21 at 1.5-2.5%.
“We expect Infosys to raise revenue growth guidance to 2.5-3.5% in constant currency and retain EBIT margin guidance of 23-24%,” Nomura’s Parikh said in the note. “We expect HCL Technologies to retain revenue growth and EBIT margin guidance, while Wipro may guide for 1-3% quarter-on-quarter growth for Q4.”
Valuations
Technology firms were among the top performers in 2020, with the Nifty IT Index ending the year 55% higher—the best since 2013. All constituents of the 10-stock gauge ended with gains of more than 25% for the year.
In Q3, the Nifty IT Index gained more than 21%, primarily on account of deal wins by L&T Infotech Ltd., Infosys and Mindtree Ltd.
“IT stocks have rerated on the back of improved growth visibility and trade at a 27-43% premium to average valuations,” Akshat Agarwal of Jefferies said in a note. “However, valuations seem reasonable as earnings yield differential to bond yields remain at average levels.”
Jefferies has highlighted Infosys as its top pick in the sector. The research firm raised its price target on the stock to Rs 1,550 apiece from Rs 1,380, citing revenue growth leadership. It has also listed HCL Tech among picks on the back of offering similar growth at a 25-35% discount to Infosys and TCS. Jefferies raised its price target on HCL Tech to Rs 1,160 apiece from Rs 980.
Watch Out For
- Outlook on IT budgets in 2021 and potential for acceleration driven by increasing shift to digital
- Demand trends in large verticals
- Investment in sales, delivery, re-skilling to cater to changing demand patters
- Hiring plans and wage hikes
- Capital allocation policy
- Currency risks and impact of immigration norms
- Pick-up in outsourcing as well as offshoring in the wake of the pandemic
- Outlook on BFSI, retail vertical and recovery prospects
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