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Last Updated : Jul 03, 2020 01:51 PM IST | Source: Moneycontrol.com

COVID-19 to dent IT earnings in Q1FY21 but these 2 stocks remain top picks

Brokerages say the demand pullback is expected to be severe in the directly impacted segments but BFSI and telecom could be stable in terms of growth for IT companies.

Sunil Shankar Matkar
 
 
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The June quarter earnings of information technology (IT) companies are expected to be hit by demand-side challenges as well as supply pressure, as the coronavirus outbreak takes a toll on the business.

The lockdown imposed to check the spread of the virus hit the supply side. Though some countries started easing restrictions and lifting lockdown in May but IT firms could not operate at full capacities due to the virus risk, which forced companies to lower discretionary spend, review pricing, delay the ramp up of deals and acquisition, which will spill into September quarter as well, brokerages say.

Brokerages expect IT companies to report a 5-9 percent sequential decline in constant currency revenue for the June quarter, with cross-currency headwind of 20-70 basis points, which may further impact dollar revenue growth QoQ.

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"We expect Tier-1 IT companies to report a revenue decline in the range of 5-8 percent QoQ in constant currency (CC) terms. This, coupled with cross currency headwind of 30-60 bps, will further negatively impact dollar revenue growth," said ICICI Securities.

Kotak Institutional Equities expects a sequential revenue decline of 5-9 percent and sequential cross-currency headwind of 20-70 bps largely from INR/USD movements.

According to them, country's largest IT services providers TCS and Infosys are expected to report more than 5 percent QoQ decline in revenue.

Tech MahindraWipro and HCL Technologies are likely to see around 8-9 percent sequential fall in the topline but L&T Infotech may be best among them as well as midcaps, reporting 4.5-5 percent decline in revenue QoQ.

The demand pullback is expected to be severe in directly impacted segments but BFSI and telecom could be stable in terms of growth for IT companies.

"Directly impacted segments of travel, transportation, hospitality, retail (department stores and apparels) pulled back spending with magnitude of cut varying from 20-40 percent," said Kotak. The impact of these cuts would be visible through June and September quarters, it said, adding it expected a sharp revenue decline in the oil and gas segment.

It also expects a moderate revenue decline in banking and stable revenues in insurance and telecom verticals.

In addition, ICICI Securities says, companies with higher BPO revenues are also expected to be impacted by supply-related challenges and lower client approval for work from home mode.

"Headwinds are higher than tailwinds before a decision on variable compensation. Companies have anywhere between 3-4 percent of revenues tied to variable compensation; the extent of flex on this will determine margins," Kotak said. An 8 percent decline in revenues can lead to 3-4 percent hit on utilization and 120-150 bps impact on margin (assuming relatively lower hit to onsite utilization) and (3) operating leverage hit due to revenue decline, it said.

ICICI Securities expects margin of Tier 1 companies to decline around 32-200 bps while among Tier 2 companies NIIT and Tech Mahindra are expected to post a margin decline of around 161-200 bps.

"This is mainly due to a dip in utilisation, pricing pressure and cross currency headwind, partially offset by rupee depreciation, lower travel cost and lower general administrative cost," ICICI Securities said.

More or less Kotak's expectations with respect to margins are along similar lines.

Brokerages say IT companies may continue to avoid giving full-year guidance, given the uncertainty due to coronavirus but they expect a revival in the second half of FY21 and strong growth in FY22.

"While the pandemic is expected to impact near-term growth, we expect a revival in H2FY21. This, coupled with increased traction in digital technologies, vendor consolidation opportunity for Indian IT players, improved IT spending bodes well from a long-term growth perspective," ICICI Securities said.

Kotak said it expected a weak FY21 but FY22 revenue growth would be as high as double digits on the back of spending on core transformation programs, vendor consolidation again for offshore pure plays and pickup in IT spending. “We expect TCS and Infosys to capitalise on this growth opportunity," it said.

Stock picks

ICICI Securities prefers Infosys among Tier-1 and L&T Infotech among midcaps. Kotak said Infosys is its top pick while L&T Infotech is a solid compounding play in the mid-tier category.

"We would wait for a better entry point for TCS. Even as we expect HCL Technologies to report weak near-term financials, we believe that its IT services portfolio of business has a long runway for growth. Tech Mahindra is inexpensive," Kotak said.

Disclaimer: The above report is compiled from information available on public platforms. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
First Published on Jul 3, 2020 01:51 pm
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