Muted, weak and soft. These are some of the words that analysts are throwing up to project earnings for IT service providers for the quarter ended December 2022. The trend highlights the start of perhaps a long winter for them.
IT companies, which generate most of their revenues from export of services, are likely to be impacted due to recessionary pressure in the US – their biggest market – and other western nations.
“We see potential for negative surprises across the board on revenue led by higher furloughs and pressure on the existing book of business,” said Nitin Padmanabhan, an analyst at Investec Securities.
Earnings commentary from Accenture last month was foreboding. IT companies have also reduced their expectations themselves. However, there are some hopes that top names may maintain their growth guidance.
Revenue stagnation
IT companies have just come through their golden period as the increased tech adoption during pandemic led to a rapid revenue growth. Though things are not looking up from here, they are also not looking down.
“We expect muted revenue growth of 0-3 percent (quarter on quarter) for our coverage universe,” said Kawaljeet Saluja, an analyst at Kotak Institutional Equities. “Revenue growth will moderate to high-single digits to low-teens on YoY comparison.”
Also read: Accenture second-quarter forecast disappoints as IT spending weakens
Saluja said the EBIT margin of IT firms that was contracting for a few quarters now will likely improve, albeit moderately. TCS and HCL Tech should report relatively better quarter, while Tech Mahindra and Mphasis should lag, he added.
Dipesh Mehta of Emkay Global echoed the observation. “We expect the revenue growth momentum to moderate in Q3 on account of furloughs, lower number of working days, deferred spending by few clients, and increased cautiousness among clients amid macro uncertainties and high inflationary environment,” he said.
Mehta expects constant currency revenue growth of 0.8 percent to 3.7 percent for Tier-I companies with cross-currency impact of 20-50 bps on reported USD revenue and of negative 0.4 percent to positive 3.4 percent for mid-cap firms with cross-currency impact of 10-30 bps on reported USD revenue.
Investors should note that the flat revenue growth is coming at a high base. Meaning, they will still be growing, although at a slower pace.
Deal wins: Unexciting?
Deal wins, which reached record highs earlier last year, could be in line with historical trends in most cases, said Padmanabhan, but highlighted that these are deals that have been in the making since Q1FY23. From Q4FY23, lower deal flow could be seen as clients trim their spending.
Kotak also said it expects steady but unexciting deal win numbers from IT companies. Many companies have announced a few interesting deals in the three months, with TCS leading the pack.
“We believe TCS could report TCV (total contract value) of $9-10 billion. We expect $2.5 billion of TCV from Infosys and HCL Tech,” said Saluja. “TCV growth for the sector moderated in the last four quarters though that failed to impact growth since many deals were discretionary shortcycle programs.”
Stock talks
The market has already reflected some of the lower projections on earnings. However, low-level buying in some names has kept it afloat so far. In the last one year, the Nifty IT index has delivered merely 2 percent returns.
Among the biggest names, Tata Consultancy Services (TCS) has seen a drawdown of 15 percent in the last year. In the same period, Infosys is down 21 percent, HCL Tech 22 percent and Wipro 46 percent.
“The risk for IT services stocks is continued revenue weakness in H2FY23 followed by a tepid start to FY24,” said Padmanabhan. “This could bring down Tier-I growth expectations to 6-7 percent vs 8 percent currently, leading to a potential contraction in P/E multiples.”
The selloff in some names have made them attractive. However, all investors are not rushing to buy as they wait and watch the development.
“We expect investors to focus on growth/decline in IT budgets for CY2023, the state of demand, and the pace of decision making. Infosys, HCL Tech and Mphasis are our top picks,” said Saluja.
Emkay said its pecking order is Wipro, Infosys, Tech Mahindra, HCL Tech, and TCS among Tier-I players, and Zomato, Mphasis, Birlasoft, Firstsource Solutions and Persistent Systems among mid-caps.
Key monitarables:
- CY23 IT budget
- FY23 revenue growth/margin guidance
- Deferment or cancellation of projects due to macro uncertainties, high inflation, and supply-chain disruptions
- Management commentary on the changing nature of deals (cost takeouts vs. business transformation) and potential impact on tech spending from high inflation and economic slowdown
- Demand trends in key verticals such as BFSI, retail, manufacturing, and communications
- Segments exhibiting weak demand trends;
- Deal intake/pipeline
- Pricing environment
- Attrition.
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.
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