Indian IT shares soar on expected positive Q2 performance

By Srinath Srinivasan

Ahead of the Q2FY21 results, shares of IT services firms such as TCS, Infosys and Wipro are showing positive outlook. Brokerages estimate the sequential revenue growth for the sector to lie between 1.8% and 3.7% in constant currency terms and 1-5% in dollar terms for the quarter ended September 30.

As per a recent Kotak Institutional Equities report, this will largely be due to reasonable demand trends across financial services, telecom and insurance and supply-side factors that impacted revenues in June 2020 quarter trickling down. Rupee depreciation, reduced travel and rental costs promise increased margins. Analysts at Kotak expect Tech Mahindra to report the highest increase in Ebit margin on a sequential basis at 193 bps followed by TCS at 161 bps. However, due to the work-from-home infrastructure and subsequent data security investments, analysts are cautious in asserting a substantial improvement.

“Further, the shift to work from home will require changes to the SEZ export incentive policies. We raise our Ebit margin estimates by 40-150 bps over FY22-23 forecast across Tier-1 IT. As a result, our earning per share estimates are up 1-16% across Tier-1 IT, including TechM,” analysts at Nomura Research India said.

Among top business segments, digital is expected to show growth. Analysts at Nomura said banks witnessed a sharp increase in the number of digital log-ins, growth in mobile internet users and the rise in transaction volumes in the past two quarters.

McKinsey’s digital sentiment survey also revealed a 20-100% rise in the number of online users across industries in the US. “This necessitated overall core transformation of enterprises, including shift to cloud, using data & analytics to roll-out new products and automation to reduce process bottlenecks,” it added.

Evolving trends indicate increased outsourcing due to stretched client financials and specialised capabilities that Indian IT firms possess over cleint’s in-house technical teams. This may reflect positively on their results.

Earlier, Gartner’s IT spending forecast predicted a 7.5% CAGR on outsourcing (vs 4% CAGR between 2010 and 2019) vs 2% CAGR for in-house IT spending, all over the expected period of 2020-2022. Nomura analysts said within verticals, BFSI and telecom have led the push on outsourcing (68% of IT spending in these sectors is outsourced as of 2019, as per Gartner), followed by retail, healthcare, manufacturing and energy (65% of IT spending in these verticals is outsourced).

On the deals front, Indian IT majors have healthy pipeline with payments and closures coming through in the last two quarters. Analysts at Kotak Institutional Equities said, “The deal pipeline is strong across all companies led by a mix of digital foundation, integrated deals from smaller clients, experience transformation and core transformation deals.”

Total contract value numbers are expected to be robust across large companies fuelled by mega and large deal wins and awards of contracts that were initiated pre-Covid. “For example, Infosys’ numbers will be bolstered by Vanguard deal and TCS by Phoenix. HCL Tech’s mega deal was reported in media, while Wipro announced a couple of interesting wins. Mphasis among mid-tier companies will likely report a strong number powered by the $216-million three-year deal signed in July 2020,” the analysts said. The mega deals are expected to put HCL Tech as top performer with 3.7% growth in constant currency terms for September quarter.

Going forward with the December quarter, analysts expect the guidances of Infosys, HCL Tech and Wipro to be in the range of 1-3%, 1.5-2.5% and 0-2%, respectively. Management commentaries on crucial variables like furloughs, pricing, discounts and rebates are also expected to be tracked closely. With a very positive outlook, analysts have given Indian IT stocks ‘buy’ rating ahead of the Q2FY21 results.