Tech companies, which have been in the limelight since the coronavirus pandemic broke out, are set to kickstart financial year 2022 on a strong note, with most analysts expecting strong growth in revenue across the sector.
According to analysts, largecap IT firms could report revenue growth of 2-4.5 percent in constant currency terms, while the midcap IT firms are likely to register a 3-7 percent growth on a sequential basis. The strong deal pipeline and increased spending across verticals will be the key drivers for revenue growth, they say.
"IT companies have not seen any impact of the second Covid wave on the topline. Further, this being a seasonally strong quarter, coupled with acceleration in digital technologies & improved deal pipeline are further expected to drive IT companies' revenues," said ICICI Direct.
The brokerage expects BFSI, retail, manufacturing, hi-tech and life-science to drive revenues in the quarter. In addition, the brokerage expects a discount reversal in companies having exposure to travel verticals.
Furthermore, "IT companies are also seeing a demand tailwind in terms of cost takeout by clients (led by higher offshoring & automation), vendor consolidation opportunities and traction in small & medium deals, which could further propel demand in coming quarters," said the brokerage.
Kotak Institutional Equities also expects a strong QoQ revenue growth, which will be driven by seasonal strength and increased spendings.
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"We expect Infosys to lead the growth in Tier-1 IT companies with sequential growth rate of 4.5 percent, followed by TCS (3.7 percent in constant currency), and Wipro (3.1 percent on an organic basis, 9.4 percent including Capco and Eximius Design acquisitions)," said Kotak.
"Tech Mahindra (2.3 percent reported, 1.5 percent organic) and HCL Technologies (1 percent) will report muted quarters. Revenue growth will likely hit 9.3-19.2 percent on YoY comparison courtesy to favourable Covid-impacted base quarter comparison of June 2020 and strong rebound in subsequent quarters."
Midcap Segment Growth
"Mid-tier companies will report strong growth led by strong growth from top clients, a mix of higher spending and share gains. Path towards normalization of spending in the impacted vertical of travel and transportation and accelerated digital spends," said Kotak which sees Mindtree will lead the way with 6.8 percent QoQ growth, followed by Mphasis (5 percent in constant currency) and L&T Infotech (3.5 percent).
Motilal Oswal also expects upbeat revenue traction in midcap IT firms, with the exception of Cyient, which may decline by 4 percent QoQ and the impact of COVID-19 on the workforce during Q1 FY22.
Margin Performance
Overall, the earnings before interest and tax (EBIT) margin is expected to decline across the board.
"Reasons for the decline are threefold—(1) companies such as TCS, Tech Mahinda, L&T Infotech and L&T Technology Services have rolled out wage increases, (2) decline in utilization rates as strong demand normalizes trends after abnormally high rates in the past two quarters and (3) impact of attrition and tight labor market conditions leading to higher cost of lateral recruitment," said Kotak.
The brokerage expects a sequential EBIT margin decline of 110-260 bps for companies that have announced wage revisions.
In case of midcaps, ICICI Direct feels Tier-2 IT companies' margins are expected to be impacted in the range of 40-300 bps mainly led by wage hikes. "L&T Infotech is expected to be impacted the most due to reversal of provisions in SG&A and wage hike impact," said the brokerage.
FY22 Commentary
Infosys and Wipro are expected revise their full-year and quarterly guidance, but HCL Technologies is likely to retain FY22 revenue growth guidance.
"We expect Infosys to revise its FY22 revenue growth guidance upward to 13-15 percent in constant currency YoY (current 12-14 percent). HCL Technologies is expected to retain its double-digit revenue growth guidance for FY22. Wipro is expected to guide for 5.5-7.5 percent constant-currency QoQ revenue growth for Q2FY22," said Emkay Global.
Kotak expects others firms to maintain a healthy demand outlook.
"TCS can grow in mid-teens in FY22, while Wipro will hit double-digit organic revenue growth after 10 years. Mid-tier companies are in the race of calling out industry-leading growth. Mphasis expects to report industry-leading growth in Direct International. Mindtree also expects industry-leading growth. Consensus expects L&T Infotech to hit 16 percent growth in FY22," the brokerage explained.
Top Picks
Brokerages expect IT stocks to continue trading at premium valuations given the order pipeline and digitalisation. Infosys, Tech Mahindra and HCL Technologies are the top consensuses picks.
Kotak is constructive and recommended Infosys as the top pick followed by Tech Mahindra and HCL Technologies.
Emkay, which prefers Tier-I stocks over midcaps, said its pecking order is Infosys, HCL Technologies and Tech Mahindra.
ICICI Direct prefers Infosys among tier-1 companies and Mindtree & Coforge from the midcap segment.
"Strong sequential growth and the expectation of a lucrative guidance for FY22 should help sustain the rally in IT stocks, despite their premium valuations," said Motilal Oswal which continued with a bottom-up stance for sectorial picks.
Among largecap players, the brokerage likes Infosys and HCL Technologies. "We expect Infosys to deliver top quartile growth, backed by strong deal wins ($14 billion in FY21, up 56 percent YoY), justifying its premium valuation. HCL will receive dual benefit from massive Cloud adoption, given its resilient expertise in IMS and gradual pickup in P&P, led by its ability to transform and renovate legacy products," the brokerage reasoned.
In the midcap space, Motilal Oswal prefers L&T Technology Services, Mphasis, Cyient, and Zen Technologies.
"We expect L&T Technology Services to deliver strong growth (on a lower base) for FY22, led by a recovery in the ER&D industry. We expect a recovery in Cyient on stabilization in the Aerospace vertical and increasing ER&D spends. Zen Technologies remains a tactical play, with an expected business recovery on management change and the adoption of a new strategy," the brokerage reasoned.
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