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Midcap IT firms likely to maintain growth outperformance over Tier-1 in Q4FY22

Management commentary on large deals pipeline and deal closures would be important to gauge confidence on growth continuity and better predictability, says Emkay Global.

April 06, 2022 / 02:13 PM IST
 
 
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Emkay Global expects the revenue growth momentum of IT companies will remain healthy in the last quarter of FY22, with midcap firms continuing to outperform the Tier-1 (large-caps) despite seasonality factors.

After significant outperformance in first half of FY22, the Nifty IT index return came in line with the broader markets in the second half.

The Nifty IT index was up 3.7 percent in second half of FY22, outperforming Nifty50 that fell 0.87 percent in the same period, while the Nifty IT index fell 6 percent during the March quarter, largely due to profit taking on high valuations concerns, against 0.6 percent gains reported by Nifty50.

"We expect companies in our coverage universe to report steady revenue growth on the back of a secular demand environment, healthy ACV (annual contract value) deal wins and M&A activities, although seasonal factors should weigh on sequential growth," says Emkay Global.

The brokerage further says the demand environment continues to remain broadbased, driven by strong demand for digital, cloud, data analytics, 5G, IoT, cybersecurity and AI.

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Emkay expects revenue growth of 0.9-4.9 percent QoQ in dollar terms and 1.2-5.2 percent growth in constant currency terms for Tier-1 companies. "Midcap companies should continue to outperform, with growth in the range of 3.5-7.5 percent QoQ in dollar terms and 3.6-7.6 percent growth in constant currency terms for the quarter ended March 2022."

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Guidance

On the guidance front, the research house expects Infosys to guide for 12-15 percent YoY revenue growth in constant currency terms, with 22-24 percent EBIT margin for FY23.

For FY22, the country's second largest IT services company expects revenue growth in the range of 19.5 percent-20 percent for FY22 and margin at 22-24 percent.

According to Emkay, HCL Technologies is likely to guide for double-digit revenue growth, while lowering EBIT margin guidance range to 18-20 percent for FY23. Wipro, which generally gives quarterly guidance, is expected to guide for 2-4 percent revenue growth on sequential basis in constant currency terms for Q1FY23, says the brokerage.

During the quarter ended March 2022, IT stocks corrected due to high valuations concerns and overall market correction, but in full year FY22, midcap IT stocks outperformed largecaps.

In Q4FY22, Coforge, Wipro, Tech Mahindra, L&T Infotech, HCL Technologies, Mindtree and L&T Technology Services corrected 9-24 percent, while Infosys and TCS ended the quarter on a flat note.

During the year, Mindtree beat every stock in the Nifty IT index, rising 106 percent. L&T Technology and Mphasis gained more than 90 percent each, while the rest gained in the range of 18-52 percent.

"Midcap companies are likely to maintain growth outperformance over Tier-1 companies due to consistent execution, a better level playing field with shrinking deal sizes, client mining, and steady deal wins and pipeline," says Emkay Global.

Higher employee churn and a shortage of skilled resources remain the key challenges in the short term, it feels.

Deal Intake

Emkay expects the deal intake to remain healthy across companies in Q4, driven by an uptick in smaller deals as deal tenures have become shorter due to clients' urgency to execute digital transformation projects in a short span rather than signing large, longer-tenure deals which follow lengthy due diligence and legal processes.

Management commentary on large deals pipeline and deal closures would be important to gauge confidence on growth continuity and better predictability, says the brokerage.

Most of experts believe IT sector is going to be outperformer for coming years and will continue to trade at premium valuations.

Margin Performance

Except for Coforge, Mphasis, and eClerx Services, Emkay feels EBIT margin is expected to remain flat to lower sequentially due to higher backfilling costs amid a tight labour market, increase in travel and other discretionary costs with the easing of travel restrictions and back to office trends.

"HCL Technologies, Tech Mahindra, Mindtree, Persistent Systems and Firstsource Solutions are expected to report relatively higher sequential declines in margins, with the rest reporting largely flat margins," says the brokerage.

Key things to watch out for

FY23 revenue growth and margin guidance; CY22 IT budget; management commentary on any impact on tech spending from higher energy prices, inflation and potential economic slowdown; and demand trends in key verticals such as BFSI, Retail, Manufacturing and Communications will be key things to watch out for, says Emkay.

In addition, other key monitorable things would be deal intake/pipeline in Q4; pricing environment considering high inflation and tight labour markets; margin outlook; and supply-side challenges and 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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