We see large cap IT (ex TCS) as being egregiously under-priced, especially in the context of our expectation of positive second derivative on revenue growth in FY19 as well as improving capital allocation across the board. We expect organic revenue growth in constant currency terms to improve for all large cap companies within our coverage universe in FY19 with Wipro expected to see the largest acceleration and TCS the lowest.
However, on an absolute basis, we expect revenue growth to be in a narrow range of 7-8% across companies, with TCS expected to lead alongwith Tech Mahindra. As highlighted in our earlier research, we see three key trends as being supportive of growth in FY19/FY20:1) Digital moving from point solutions to end-to-end projects (front-to-back), which favours offshore centric scale players with an innate understanding of customers’ core technology landscapes, 2) market share gains in front-ended digital engagements given investments made in reskilling employees, acquiring assets and building partnerships over the past 12-24 months, and 3) receding pressures on pricing as the onus of driving productivity moves to harder to pull off initiatives like cognitive automation from the current process-based initiatives.
We also see Tech Mahindra and Wipro as being better placed to grow their margins, with Infosys expected to defend margins better in FY19 as well given an expectation of abatement in realisation pressures that the company faced in FY16 and FY17. We raise our target multiples and target prices across the board.
We reiterate Tech Mahindra as our top pick and expect the company to continue to surprise positively on margins. We upgrade Infosys to BUY given an expectation of digital and US BFS driven market share gains in FY19 (though modest), better margin defensibility and attractive relative valuation (cheaper than Wipro for same topline growth). INR appreciation is the key risk to our estimates.
* Tech Mahindra – margin surprises to continue driving material upside to consensus estimates. We expect EBITDA margin to increase by 100bps QoQ to 15.5% in Q3FY18, with exit EBITDA margin likely to be 16.5% in Q4FY18. Resource optimisation, productivity improvements, utilisation headroom and turnaround in acquisitions like LCC and Comviva are expected to be the key margin levers for the company. Our FY19E EPS estimate is ~7% higher than consensus. We expect new deal momentum to sustain at a quarterly run rate of US$300-350mn and would expect TechM to grow modestly faster than the industry average in FY19 with enterprise segment to witness a near double digit growth and communication vertical to recover to a growth of 6-7%. Large clients within the communications segment are expected to witness growth only from Q1FY19 though with H2FY18 expected to be modest. Our revised target price of Rs600 is based on 14x Dec’19E EPS and presents an upside of 22% including dividend yield.
* Infosys – investments in digital to help modest market share gains in FY19 and stable pricing to help margin management. Though Infosys as of now expects aggregate demand environment for the industry to probably remain largely unchanged in FY19, it nonetheless remains confident in its ability to drive better growth for itself given improving competitive positioning in digital services. New services, which represented 9.4% of overall revenues in Q2FY18 and witnessed revenue growth of 14% QoQ, should sustain the momentum in H2FY18. Apart from Cloud services, Infosys is seeing encouraging early traction in services around IoT, cyber security and API economy as well. Apart from Retail and Hi-tech verticals, which are somewhat challenged, most other verticals including US BFS should do well for the company here-on. We believe that margins should have an upward bias in FY19/FY20 given that blended realisation which had declined by 1.1% and 1.9% in CC terms in FY16 and FY17 respectively and acted as a margin drag, should be stable here-on given maturity of automation capabilities. Our revised target price of Rs1190 is based on 16x Dec’19E EPS and presents an upside of 18% including dividend yield.
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