Three mid-cap tech stocks may outsmart large-caps as Q4 earnings keep D-Street booming

The Street is bullish on a few mid-cap IT stocks and projects the growth range for them to be wider than that of large-cap companies in Q4.

The outlook for the IT services sector remains cautious, with growth projections staying subdued. The Street is, however, bullish on a few mid-cap IT stocks and projects the growth range for them to be wider than that of large-cap companies in Q4FY23, ranging from negative 5 percent to 5 percent quarter on quarter (QoQ) in CC (constant currency) terms, according to Asian Market Securities (Amsec).

According to Motilal Oswal, "Tier-II players are expected to have a wider growth range of -1.1 percent to +5.4 percent QoQ in CC terms."

IDBI Capital expects revenue growth of negative 1 percent to 3.5 percent QoQ (organic) in CC terms in its mid-cap coverage.

Coforge

Coforge is expected to lead the pack with a 3.5 percent CC QoQ growth, led by insurance, and the travel, transportation and hospitality (TTH) verticals, with EBIT (earnings before interest and taxes) margin to expand by ~166 basis points (bps) QoQ to 16.2 percent on the back of improved utilisation, tailwinds, and easing supply-side challenges, it said.

Amsec also projects a similar growth rate of 3.3 percent QoQ in CC terms and believes that the adjusted EBITDA (Earnings before interest, taxes, depreciation and amortization) margin will improve by 160 bps QoQ to 20.1 percent, mainly led by growth leverage and better cost efficiencies.

While the stock broking firm has a ‘buy’ rating on the company, it highlights that the company has high exposure to the BFSI sector and will need to be closely monitored to understand the impact of the banking crisis on their revenues, going forward.

“We would be keenly monitoring the incremental impact on BFSI (50 percent of revenue) and FY24 outlook,” says Motilal Oswal, with a ‘hold’ rating on the company but expects it to meet its FY23 revenue growth guidance of 22 percent YoY CC and growth momentum to stay intact in Q4 with 3.1 percent QoQ CC.

Also Read: Q4FY23 preview: Indian IT services to see muted revenue growth due to global banking turmoil

Cyient

Motilal Oswal expects Cyient to lead revenue growth under its mid-cap universe.

“Among Tier-II firms, we expect CYL’s top line to grow at 5.4 percent QoQ in CC terms, followed by Coforge and PSYS (Persistent Systems) with 3.3 percent/3 percent QoQ CC revenue growth. MPHL (Mphasis) and ZENT (Zensar Tech) could see a revenue decline of 1.1 percent/0.8 percent QoQ in CC,” it said. The brokerage expects a strong rebound in Cyient’s Design Led Manufacturing (DLM) business. It expects a strong revival in the aerospace segment and the railways segment to stabilise.

“Growth will be led by DLM, which is expected to grow 25 percent QoQ. Organic services are expected to grow 2 percent QoQ in CC terms, led by growth in aerospace, railways and communications. Aerospace is expected to post a strong ~10-11 percent QoQ growth in CC terms. We expect margins to improve by 60 bps QoQ, led by growth leverage and operational efficiencies (SG&A reduction),” says Amsec, which projects a revenue growth at 5.2 percent QoQ CC revenue growth.

IDBI Capital also has a ‘buy’ rating on the company and believes revenue growth to come in at 5.5 percent QoQ and forecast EBIT margin to improve by 60 bps QoQ to 13.5 percent due to cost optimisation and price hikes.

Also Read: HCL Tech drops 1% after JPMorgan puts it on negative catalyst watch

Zensar Tech

In addition to Cyient, Motilal Oswal prefers Zensar Tech among Tier-II IT players. It believes Zensar’s valuation remains attractive and that a good margin recovery and new CEO's focus on execution should help stabilise revenue growth and recoup margins.

On Q4FY23 earnings, it expects a 0.8 percent QoQ decline in CC revenue attributed to Hi-Tech and Manufacturing remaining weak. “The order book should see good growth on positive seasonality. Despite pressure on growth, we expect a strong margin expansion of ~110bp QoQ, fuelled by cost optimisation and receding recession,” it added.

Q4 growth will remain flattish. However, EBIT margin will improve by 154 bps QoQ to 8.65 percent, led by operational efficiency, increased utilisation, and easing supply-side challenges, said IDBI Capital with a ‘buy’ rating on the stock.

As per Bloomberg data, Coforge currently has 27 ‘buy’, 2 ‘hold’, and 7 ‘sell’ analyst calls with an average 12-month target price (TP) of Rs 4,647.6. Cyient has 16 ‘buy’, 3 ‘hold’, and 0 ‘sell’ calls at an average TP of Rs 1,078.3 while Zensar Tech has 10 ‘buy’, 4 ‘hold’, and 0 ‘sell’ calls at a TP of Rs 298.4.

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