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The last quarter of 2020 will be one of strong sequential growth for India’s IT sector, aided by robust demand, large deal wins and increased spending on digital, recent reports by research houses have said.
This is unusual, given that the December quarter is a seasonally weak period for tech firms -- and more so this year due to the impact of the coronavirus pandemic.
India’s “IT sector is set to post its strongest 3Q sequential growth of the past eight years, despite the seasonality factor and the volatile macro situation,” a note by HDFC Institutional Research said.
Echoing similar sentiments, a report by Kotak Institutional Equities (KIE) said many companies will return to year-on-year growth trajectory and Q3 might also see revenue upgrade for some firms.
Brokerage firm Motilal Oswal said the expected strong Q3 growth will sustain the momentum in IT stocks .
Sector leader TCS will be kicking off with its results on January 8. Infosys and Wipro will declare results on January 13, followed by HCL Tech on January 15.
The strong growth estimate for the third quarter, according to brokerage firms and analysts, is driven by four key factors:
- Increased spending in digital as enterprises migrate to cloud to ensure business continuity. This would only accelerate in the coming months.
- Vendor consolidation as enterprises looked to cut down costs, resulting in largedeal wins for IT majors. For instance, Infosys’ Vanguard deal in July is a part of vendor consolidation.
- Robust execution of contracts despite the disruption caused by the pandemic
- Lower-than-expected furloughs in December 2020, which is seasonally a weak quarter for these firms.
As the momentum continues and discretionary spending comes back, the sector could return to double-digit growth in FY22, the note by HDFC added.
IT sector growth amid the pandemic
The IT sector was one of the biggest gainers amid COVID-19. Stock prices of large IT firms saw an average 50 percent jump bang in the middle of the pandemic. This was a result of the sector’s ability to shift to a new working model of work from home and catering to the changing client needs. Therefore, the disruption that it saw compared to other sectors was also minimal.
After the negative sequential growth for the quarter ending June 2020 (barring Infosys), Q2 saw a significant quarter-on-quarter growth of around 6 percent for the top three firms.
However, pricing pressure has now largely eased and executives have said that conversions around large deals have increased, though for engineering services deals decision cycles are longer.
How does growth look for IT firms?
Wipro is setting its sights on large deals and focuses on Europe, which currently accounts for about 24 percent of its revenue. Thierry Delaporte, CEO, Wipro said during Q2 results that the company has good visibility for Q3 and Q4 and is confident about winning large deals. It recently won a $700 million deal from German Metro AG, and this deal size could go up to $1 billion.
During recent analysts' calls, TCS said that it is looking at a multiyear opportunity in the area of cloud adoption. It recently took over IT units of its two banking clients Deutsche Bank and Prudential Financial Inc. Salil Parekh, CEO, Infosys, said during a media event in mid-December that momentum in large deals continues and decision making on deals has been similar to that of Q2.
Brokerage firm Motilal Oswal estimated an average 3 percent quarter-on-quarter growth for top IT firms, whereas HDFC Institutional Research note has pegged a 3.7 percent for the sector.
Analysts expect marginal upgrades in guidance of IT firms for the March 2020 quarter. Infosys had given revenue guidance of 2-3 percent for FY21 and Wipro 1.5-3.5 percent for Q3. HCL Tech’s revenue guidance stood at 1.5-2.5 percent for FY21. TCS does not provide quarterly or annual guidance. TCS, analysts said, is likely to give a strong outlook for Q4.
While migration to cloud and digital spends are increasing, it is not clear how sustainable are these opportunities in the long run. The KIE note points out that there should be focus on longevity and magnitude of opportunity from aggressive cloud shifts by clients.
Lockdowns have already been imposed in some regions in Europe on the back of the second wave of the pandemic. Considering that Europe is one of the fastest growing sectors for IT firms currently, it is not clear if this would impact growth. The region accounts for about 25-30 percent of top IT firms’ revenue.
Sounding a note of caution, Parekh had said: “At this stage, we have not seen anything that is different from what we were seeing in terms of the activity. Of course we are extremely watchful. We will see how that plays out. We are obviously quite careful.”