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IT Q3 Preview: 3 stocks to bet on as robust QoQ topline growth likely with upward revision in full year growth forecasts

The deal pipeline is strong across companies led by digital foundation deals, integrated deals from smaller clients, experience transformation and even core transformation deals.

January 05, 2021 / 09:21 AM IST
 
 
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IT services providers are expected to continue to report robust revenue growth in the third quarter of FY21 (October-December) as well, which is generally a seasonally weak quarter for the sector due to holiday season.

Recovery in key verticals, strong demand tailwinds, continued increase in digital spends especially after COVID-19, large deals ramp-up and lower-than-expected furloughs could help these IT companies show robust revenue growth in the range of 2-3 percent, while mid-tier IT services companies could report revenue growth in the range of 1.5-5.5 percent.

"Healthy order pipeline, large deal signings, strong earnings from Accenture, and absence of headwinds like a repeat of the COVID-19 led lockdown in Q1FY21 or uncertainty with regard to the outcome of the US Presidential election should drive the outperformance in Q3 versus management guidance in Q2FY21," said Motilal Oswal.

"Multiple mega-deal wins in Cloud and Captive (TCS – Postbank and Pramerica, Infosys – Rolls Royce and Daimler, and Wipro – METRO AG) should add incremental growth to an already buoyant organic growth momentum," the brokerage added.

The deal pipeline is strong across companies led by digital foundation deals, integrated deals from smaller clients, experience transformation and even core transformation deals. Hence total contract value (TCV) numbers will be robust for a few fuelled by mega and large deal wins, awards of contracts.

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According to Kotak Institutional Equities, revenue growth for large companies could be in the range of 2-3 percent with Wipro leading the way. On a YoY comparison, "Infosys and HCL Technologies will move to growth in constant currency, while TCS and Wipro will have marginal revenue decline. Mid-tier companies will report strong growth with L&T Infotech leading the way at 5.5 percent on a constant currency basis, Mindtree at 3.9 percent and Mphasis at 3.3 percent," the brokerage said.

Prabhudas Lilladher estimates revenue growth between 1.7-3.4 percent QoQ in constant currency for Tier-1 companies and 1.5-5 percent QoQ for Tier-2 companies.

Infosys and HCL Technologies are expected to review their full-year revenue growth guidance while Wipro is expected to forecast strong growth in Q4FY21.

"We expect Infosys revenue guidance to increase 3-4 percent YoY in constant currency (from 2-3 percent) & EBIT margin guidance at 24-25 percent (from 23-24 percent). HCL Technologies current annual guidance stands at 0.5-1.3 percent for revenue growth and 20-21 percent for EBIT margin band. We expect revenue guidance to increase to 1-2 percent & slight revision in margin guidance," Prabhudas Lilladher said.

Wipro has given growth guidance of 1.5-3.5 percent for Q3FY21. "We expect guidance for Q4FY21 to be strong 2-4 percent. This guidance does not include recent sign a large deal of Metro," said the brokerage.

As a result, the upgrade in earnings for FY21-FY22 estimates especially after December quarter results is likely to be seen.

"We expect another round of upgrades, albeit marginal, in revenues estimates for FY22 post Q3FY21 results. The demand drivers are three-fold — 1> workplace management (It is realistic to expect that remote workplaces will continue with great emphasis placed on security, collaboration, scalability and automation), 2> customer experience will become paramount as online becomes the most relevant channel of interaction, and 3> the benefits of these changes are best utilised through core transformation," Kotak said.

Prabhudas Lilladher expects IT sector to maintain its strong performance in FY22 as 1> Sector has entered into Technology Upcycle, 2> Digital becoming mainstream, 3> Strong order book & deal pipeline, 4> Accelerated demand for cloud adoption, 5> Broad-based demand across all industry verticals.

On the operating front, the earnings before interest & tax (EBIT) margin is expected to be impacted only by the wage revision, otherwise, the cost measures may remain supportive.

"TCS has rolled out wage increase effective October 1, impacting margins by -70 basis points QoQ. Wipro has rolled out promotions effective December 1, while HCL Technologies has given wage hike only for select bands. We would like to highlight that only wage hike is headwinds for margins in Q3FY21," said Prabhudas Lilladher, adding if companies are able to do cost control more efficiently there might be a positive surprise to the margin estimates.

Technology stocks had a strong run after the beginning of easing in lockdown measures. It was one of the best sectors in terms of return from March lows as well as in the last year.

The Nifty IT index rallied 55 percent in 2020 and 117 percent from March 23 low, against Nifty50 at 15 percent and 84 percent respectively in same periods. But brokerages still expect quality stocks among IT space to provide more returns in coming days.

In the largecap or Tier-I space, brokerages bet on Infosys, Tech Mahindra and HCL Technologies.

While the sector trades at 40 percent premium to its 10-year average multiple, Motilal Oswal remains positive as it expects the sector to sustain double-digit topline growth in the medium term, led by: 1 larger deals on a full-scale Digital transformation, 2) tail of projects steered by an increased focus on workplace management, and 3) higher spend on Cloud migration by large corporates.

Among Tier-I players, the brokerage likes Infosys, Tech Mahindra and HCL Technologies on expectations of industry-leading growth.

Infosys is also the top pick of Kotak which expects Infosys to lead the industry on growth in FY2022. "Tech Mahindra is a play on margin expansion and 5G opportunities at reasonable valuations. Wipro has surprised with the urgency to turnaround effort and can be interesting. HCL Technologies continues to be a strong play on digital foundation deals and long-term growth potential in ERD," said the brokerage.

Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Sunil Shankar Matkar

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