Q3 IT Preview: Revenue To Rise In A Seasonally Weak Quarter, Margins Under Pressure
The aggregate revenue of the top five IT firms is set to rise 3.88% sequentially, according to forecasts compiled by Bloomberg.
India’s biggest software exporters are expected to report a rise in revenue for the sixth straight quarter, aided by deal wins, digital transformation and rising demand for newer technologies such as cloud and blockchain. But analysts expect wage hikes, lower utilisation, hiring and a rise in discretionary costs to weigh on margins.
The aggregate revenue of the five information technology companies in the Nifty 50—Tata Consultancy Services Ltd., Infosys Ltd., HCL Technologies Ltd., Wipro Ltd. and Tech Mahindra Ltd.—is set to rise 3.88% sequentially in the quarter ended December, according to analysts’ estimates compiled by Bloomberg. Their combined net profit is projected to increase 4.42%.
“Q3 FY22 is expected to be another strong quarter for IT companies after strong performance witnessed in Q2,” ICICI Securities said in a note. “Normally, this quarter is seasonally weak due to furloughs. However, last year, we saw an aberration to this trend.”
IDBI Capital expects IT companies to report revenue growth in the range of 3-6.5% sequentially in constant currency terms.
Among tier-1 companies, Wipro, TCS and HCL Tech are expected to lead, Prabhudas Lilladher said in a note. Larsen & Toubro Infotech Ltd. and Persistent Systems Ltd. among tier-2 firms are likely to deliver constant currency growth above 9% over the preceding quarter. The brokerage expects tier-2 companies to outperform tier-1 peers on revenue growth in the third quarter.
Fluctuating currencies are likely to dampen dollar revenues, it said. “There is cross-currency headwind of 50-90 basis points due to appreciation of the U.S. dollar against the pound, euro and Australian dollar.”
Infosys, supported by the full ramp-up of the Daimler deal, may report revenue growth of 3.8% quarter-on-quarter in U.S. dollar terms, according to HDFC Securities. HCL Tech is expected to report 3.7% sequential growth in revenue, led by a recovery in its products and platforms business. Wipro is likely to post 3.5% dollar revenue growth.
BFSI, communication, retail, lifescience and hi-tech verticals will drive growth in the reported quarter, IDBI Capital said.
TCS, Wipro and Infosys will announce their third-quarter results on Jan. 12.
Operating Margin
Motilal Oswal anticipates most companies’ margins to be in a narrow range as supply pressures are likely to be offset by operating leverage. “Among tier-1 players, EBIT margin will be in a tight range of -20 bps to +40 bps sequentially, although they will see a steep decline versus Q3 FY21 profitability.”
HCL Tech’s margins, which were impacted in the last quarter by weak performance of its products and platforms business, are likely to improve sequentially in Q3 despite wage hike impact, ICICI Securities said. For TCS, it expects margins to improve owing to pyramid or business optimisations and higher offshoring. Wipro’s margins are seen to be marginally lower quarter-on-quarter on higher employee costs.
Prabhudas Lilladher sees flat or a slight decline in IT companies’ margins on a sequential basis. It expects margins to decline annually as most companies have rolled out wage hikes twice in the last one year.
“Margin headwinds of backfilling of attrition with lateral recruits at higher costs and decline in utilisation levels due to aggressive fresher hiring will be partially offset by pyramid optimisation, cost control measures and revenue growth leverage,” it said.
Guidance
Infosys and L&T Technology Services are expected to increase revenue growth guidance for this year.
“Infosys is expected to up its guidance from 16.5-17.5% to 18-19%,” IDBI Capital said. The company had started the year with a revenue growth guidance of 12-14% in constant currency terms.
L&T Technology Services in Q2 had raised the dollar revenue guidance from 15-17% to 19-20% for FY22. Prabhudas Lilladher said there will be a further upgrade to 20-21%.
HCL Tech is likely to maintain its double-digit revenue growth and margin guidance, the brokerage said. “We believe it will deliver 12% YoY growth.”
Wipro is likely to guide for 2-4% sequential constant currency revenue growth for the last quarter of FY22.
Deal Pipeline
IT companies’ deal pipeline remained at record high in the third quarter, led by demand for digital, cloud, data analytics, 5G, internet-of-things, cybersecurity and artificial intelligence.
“Demand for compressed technology transformation with focus on faster execution resulted in high velocity of small and mid-sized transformation deals,” Prabhudas Lilladher said.
Many of the transformation deals were broken down into smaller packets to reduce execution time, according to Prabhudas Lilladher. Therefore, absence of large deals or lower total contract value number, it said, does not necessarily mean weak revenue growth.
Stock Performance
For the quarter ended December, the Nifty IT Index has gained nearly 10.49%, led by Tech Mahindra, L&T Technology Services and L&T Infotech. The Nifty 50 has declined 1.50% during the period.
Watch Out For
Upgrades in revenue guidance. Infosys and L&T Technology Services are expected to increase guidance by 100 basis points, HCL Tech likely to maintain its double-digit guidance.
Margin outlook.
Large deal pipeline/bookings.
Hiring, attrition and offshoring trends.
Business impact due to sudden rises in Covid cases globally.
Demand environment for cloud/digital-led services and outlook.