IT Sector Q2 Preview | Robust revenue likely, all eyes on management views

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Despite all the talks of slowdown in demand from the US and European countries, analysts expect IT companies to deliver a 'resilient' quarterly performance with 2-4 percent sequential growth in revenues.

“The IT sector is expected to post resilient Q2 performance in context of the current macro environment. Tier-1 IT companies are expected to deliver sequential growth in the range of 2.4 to 4 percent constant currency,” said analysts at HDFC Securities in a note.

The brokerage added that mid tier companies will continue their outperformance over larger peers with Tata Elxsi, Mindtree and Persistent Systems expected to lead at above mid single digit quarter-on-quarter (QoQ) growth.

Others brokerages also have similar expectations. Elara Capital outlines average 3.8 percent QoQ growth and Jefferies has predicted a 3.6 percent jump. Antique Stock Broking expects revenue growth in the range of 2-4 percent QoQ in organic constant currency terms for top 5 and 3-5 percent for mid-caps.

According to analysis of most of the brokerages, falling margins of IT firms may have bottomed now. IT sector margins have contracted 400 bps since post-Covid peak levels.

“We’re building margin at 100 bps lower than pre-covid for FY23 and some recovery in FY24 (to around pre-Covid levels) supported by medium term tailwinds of normalisation in attrition, utilisation and pricing,” said HDFC Securities. Jefferies also expects aggregate EBIT margins to recover slightly by 30 bps QoQ in Q2FY23 after falling by 165 bps in Q1FY23.

Also read: Global IT slowdown signals Indian tech’s fall from grace

IT companies have taken many steps recently to arrest the fall in their margins, including holding back variables for employees. Nonetheless, analysts said wage impact and cross currency impact will impact margin in Q2, offset by absence of visa cost, INR depreciation, improved utilisation and efficiencies.

Slowdown impactThe growth rate for IT companies have slowed down following the boom in revenue during the pandemic. It is expected to go further down as western economies reel under the aftermath of war in Ukraine.

Though the management at top IT companies have maintained that the growth will note be impacted much due to recessionary pressure in Europe and the US, analysts have already started trimming down their expectations beyonds September quarter (Q2).

“Expect the disconnect between weak macro and tech leaders’ commentary to narrow down, with outlook turning soft hereon. We do not anticipate guidance upgrades from Infosys, HCLT and Coforge,” said Elara Capital.

Currency impact
The bygone quarter was marked by sharp depreciation in rupee against the US dollar, which is generally considered positive for export oriented IT companies. However, depreciating euro and pound have also become worries for the sector.

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Jefferies said currency headwinds will impact US dollar revenue growth. “Given the 5-7 percent depreciation of GBP & EUR against USD, revenue growth in USD terms for our coverage universe will be impacted by 165 bps in Q2FY23, slightly lower than the 185 bps impact in the last quarter,” it said.

It is expected that companies with higher exposure to GBP and EUR like Coforge, Tech Mahindra and TCS are likely to be impacted more due to the forex rate change. L&T Infotech, Mindtree and Infosys seem better placed in this regard, with cross-currency impact on revenue growth being nearly half of the previously mentioned companies.

Things to watch
The most important factor right now is management commentary on the demand environment. Any negativity shown by them will be taken into account and may hurt share prices, which are already trading at 30-40 percent discount to their 52-week high prices.

Commentary around deal pipeline, sales cycle, nature of deals and deal tenure, pricing, and vendor consolidation will also be keenly watched. Analysts and investors will also focus on any cues on client budgets or reprioritization of client spends.

Supply-side and attrition trends, hedging policies in the midst of sharp currency depreciation will be other key things to monitor.

Early earnings calendar is as follows

TCS: October 10

HCL Tech: October 12

Wipro: October 12

Infosys: October 13

Mindtree: October 13

L&T Tech Services: October 18

Sonata Software: October 18

Persistent Systems: October 19

Coforge: October 20

Mphasis: October 20

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