Shares of information technology companies have been on a roll after the big names sprang a positive surprise in the third quarter. Tata Consultancy Services (TCS), HCL Tech and Wipro topped margins estimates despite the seasonality factor. With a 6 percent quarterly growth in constant currency revenues, HCL Tech managed to outshine its peers.
For the sector as a whole, healthy deal wins and a drop in the employee attrition rate were the other highlights of the quarter. Management commentaries further contributed to the optimistic outlook, with TCS suggesting a potential turnaround in the BFSI or banking, financial services and insurance segment and anticipated growth in the upcoming quarter. Wipro's leadership has also signalled green shoots in discretionary demand.
But what does the pecking order look like following the better-than-expected quarterly showing? In an interview with Moneycontrol, Apurva Prasad, vice president, institutional research, HDFC Securities, says he prefers tech bellwether TCS over Infosys as it is poised to continue its outperformance in the coming quarters. Edited excerpts:
The big four have reported their numbers. The trend has been set as Q3 earnings have beaten muted expectations. So looking at the top four, which one is emerging //emerged// as a clear winner in Q3? Would you say it's HCL Tech given the fact that it has reported industry-beating revenue growth?
Yes, we were expecting HCL Tech to outperform in the quarter and they seem to have done that, but in the services space the outperformance is not very significant. But in any case, it sets up the company for an outperformance in FY24 and this outperformance should also likely continue in FY25. So HCL Tech, I would say, would be the best out of the top four.
TCS, relative to some of the headwinds that the company has been facing and what they've delivered, especially on margins and with some of their goalposts that they had by end of year, I think there is an upside potential in margins for the company. Broadly, the visibility of some recovery over the next few quarters and, therefore, growth rates improving for most of these companies would be a factor that is important. But what we prefer is HCL Tech and TCS within the bigger ones.
Also Read: Can’t take equity capital flows for granted even if Fed cuts rates: Neelkanth Mishra
So what is the pecking order looking like now? Would you prefer Infosys over TCS given the fact that the stock has also underperformed vis-a-vis its peers?
While Infosys has historically maintained a discount of about 15-16 percent compared to TCS, which remains consistent, I believe TCS is poised to continue its outperformance. The period during which Infosys outpaced TCS was characterised by substantial growth. However, looking ahead, I don't foresee Infosys replicating that trend in the next couple of years due to specific company challenges. There is an increased reliance on the pass-through element in some of their significant deals, which is not an ideal starting point given the current circumstances. Although there is an anticipated recovery for Infosys, with FY25 expected to fare better than FY24, I still lean towards TCS as my preferred choice. The attrition rate has come down, so on the supply side things have improved, but if you look at the headcount, we saw a second straight quarter of decline for both Infosys and TCS. Do you think the trend will continue at least for the next few quarters?
Yes, there should be a recovery on the hiring front in the next quarter or two. There is still considerable capacity in the form of a bench that provides companies like Infosys the opportunity to enhance their utilisation. The hiring strategies that preceded this period enabled them to maintain relatively lower gross hire levels and adopt just-in-time hiring methodologies, even on the campus side post-COVID. This approach allows companies to align their hiring more closely with demand rather than building a surplus, as was done previously. So, I think some of these optimisations would continue.
Also Read: HCL Tech up 4%, extend gains as brokerages raise EPS estimates on Q3 beat
Subcontracting is another form of delivery that companies have optimised and there is still enough room for reduction in that aspect. So the operational levers are looking quite favourable for the company. Notably, attrition rates are currently lower than the historical average for companies, and the cost of replacement is no longer a significant challenge. I think those factors should start to help, especially as even onshore wage inflation seems to be coming down. That is a bigger cost element. So normalisation of these factors would be another thing that would work in their favour. So margins look quite fair.
Anything catching your fancy from the mid-cap IT pack? Given the fact that mid-cap IT has performed better than large-caps, do you think valuations are stretched here?
Persistent Systems stands out within the midcap IT sector, presenting an attractive opportunity. I anticipate the company will maintain its trend of outperforming its peers, with the potential for margin improvement. Therefore, Persistent Systems is expected to outshine its counterparts. Within the smaller names, Birla Soft witnessed a turnaround in the last quarter, and this positive trajectory is likely to persist.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
