Published on 15/07/2019 2:27:44 PM | Source: Prabhudas Lilladher Ltd

IT Sector - No space for multiple expansion By Prabhudas Lilladher

Posted in Broking Firm Views - Sector Report| #IT Sector #Prabhudas Lilladher Ltd #Sector Report

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No space for multiple expansion

We expect Q1FY20E to be a mixed quarter for Indian IT services with TCS & Infosys likely to post steady revenue growth in tier-1 & Hexaware, Mphasis, LTTS to post steady revenue growth in tier-2 IT services under our coverage universe. We expect revenue growth in CC between -0.7%-3.2% QoQ for Tier-1 IT companies. We expect TCS to deliver 3.2% QoQ CC broad-based growth across verticals & geographies. We expect Infosys to deliver steady growth of 2.5% QoQ CC with ~146 bps QoQ decline in margins led by wage hike, H-1B visa costs & INR appreciation.

We downgrade Tech M from Accumulate to Hold as we believe FY20E growth prospects for Tech M are not looking exciting due to 1) Delayed spending in 5G due to global trade wars, 2) Slowdown in enterprise business, 3) Margins at peak levels. We downgrade Wipro from Hold to Reduce as we believe Wipro will continue to underperform its peers on revenue growth at 4.3-6% for FY20-21 vs peers of 8-14%. This, along with the uncertainty on revenue growth justifies the discount to its 5-year mean, only capital allocation strategy was supporting premium multiples. While Q1 is a seasonally strong quarter for IT services, we can observe pressure on YoY revenue momentum & there are headwinds on margins such as 1) Higher onsite costs, 2) Investments in digital, 3) Rupee advantage is weakening. We have already mentioned in detail in our IT services sector report (Clouded visibility, Tread cautiously) about the headwinds of IT sector in FY20E/21E. We continue to prefer only TCS as our top pick in tier1 & LTTS in tier-2 IT services.

* Mixed growth from tier-1 IT pack: We expect constant currency growth of 3.2%, 2.5%, 1.6%, 1.5% & -0.7% for TCS, Infosys, Wipro, HCLT & Tech M respectively. We expect Tech M USD revenues to decline by 1% QoQ & CC revenues to decline by -0.7% QoQ due to weakness in communication segment. We expect Infosys to post CC revenue growth of 2.5% & cross currency headwind of 40bps, revenue growth will also be aided by Starter N.V deal. In HCLT, revenue from the IBM deal to accrue only 2Q onwards. We note that for Wipro revenue growth will be lower on reported basis due to divestment of Workday business that impacted revenues by US$9mn.

* Muted growth for Tier-II IT companies: In tier-II IT companies – Hexaware, Mphasis & LTTS are expected to deliver steady revenue growth whereas LTI Cyient, MTCL may post flat revenue growth. In LTI, growth momentum is impacted by one of its big client in BFS vertical based in US capital markets. We expect MTCL to post weak deal wins and soft TCV as uncertainty arising from LTI deal will delay client decisions.

* Pressure on margins across the pack: Wage hike, visa costs & INR appreciation to erode margins across our coverage. Amongst large caps, we expect Infosys, Tech M & HCLT margins to erode by 146bps, 256bps & 151bps QoQ respectively. Transition costs of large deals won in past 3-4 quarters may continue to put pressure on margins of Infosys, HCLT & Tech M. We expect companies to guide cautiously on FY20E margins.


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