Published on 9/01/2018 4:09:05 PM | Source: Reliance Securities Ltd

IT Sector Update - Reliance Securities Ltd

Posted in Broking Firm Views - Sector Report| #IT Sector #Sector Report #Reliance Securities Ltd

Steady Quarter Likely

Sector Preview

We expect the USD revenue of the IT firms under our coverage universe to post a combined 1.9% QoQ rise in 3QFY18. Top-5 IT firms are expected to post 1.5-3% QoQ rise in USD revenue in reported terms (1.6-3.2% in CC terms) with HCL Technologies (HCLT) likely to lead. Mid-sized firms will see variation, with Cyient and Mindtree likely to lead (3% and 2.8% QoQ USD revenue growth, respectively). Crosscurrency movements were varied in 3QFY18, with the USD largely remaining flat against the EUR, appreciating against the AUD (2.7%) and depreciating against the GBP (1.5%).

The IT sector continues to face disruptive trends in terms of SMAC leading to cannibalisation of revenue, apart from pricing pressure in commoditised services, and automation. The IT industry body, NASSCOM projects 7-8% growth in IT-BPO exports in FY18 with the announcement coming as late as June 22, as against its traditional practice of providing industry growth guidance in February, owing to global uncertainty. We do not expect the industry to surpass this growth target and believe high single digit growth is realistic in the near-term.

On margin front, we expect a stable performance despite seasonal weakness owing partly to INR depreciation against key currencies including the USD (0.7%), EUR (0.9%) and GBP (2.1%), and partly due to operational efficiencies and automation. Among top-tier IT firms, we expect Tech Mahindra (TechM) to post 69bps QoQ margin expansion, followed by Infosys with 53bps expansion. TCS, Wipro and HCL Technologies are likely to see range-bound margins. Within our mid-cap coverage universe, we expect Mindtree and KPIT Technologies (KPIT) to post the maximum margin improvement of 224bps and 76bps QoQ, respectively aided by revenue growth and improved operational efficiency. We expect continuous focus on levers like utilisation and cost efficiency. On YoY basis, margin performance is likely to improve, with 6 companies of our 13 IT coverage universe likely to post expansion to the tune of 44-172bps.

We would watch for sustainable margin outlook going forward, and IT budget trend for CY18E. Focus on return of cash to shareholders is also a theme playing out, with TCS, Infosys, Wipro, HCLT, Hexaware, Mindtree and eClerx all resorting to share buy backs in order to make better usage of their cash balances. Impact of the recent US tax change is also another focal area. We continue to believe Indian IT is a bottom-up sector and stock picks will play a key role in driving alpha.

Our Top Picks: HCLT and CDSL (India).

Revenue Expected to be Steady

We expect 1.9% sequential revenue growth for the IT firms under our coverage universe. On YoY basis, growth is likely to remain in single digit at 4.2% with the exception of KPIT (12%), as the IT sector continues to get affected by disruptive trends, increasing competitive intensity and pricing pressure. This quarter, there will not be any major impact of cross currency movements with CC revenue growth likely to be in 10-20bps range to reported USD revenue growth. Company-wise, we expect HCLT to lead the top-tier IT firms, while Cyient and Mindtree are likely to lead the mid-tier firms.

Margins to See Steady-to-Improving Trend

We expect IT firms to report small expansion in EBIT margins in 3QFY18E aided by currency and operational efficiency and automation focus. Among top-tier IT firms, TechM is likely to outperform with 69bps QoQ improvement, while Mindtree is likely to post a strong 224bps QoQ expansion among mid-tier firms.

Eyes on CY18E IT Budgets, US Tax Change Impact

In our view, the street’s attention will be focused on the likely trends in CY18E IT budgets. While finalisation may still take some time, some clarity on the likely direction of spend is a key focus area, in our view. Vertically, the key BFSI and Retail verticals will be watched. Apart from this, the potential impact of the recent US tax changes is also likely to be another focus area. The increasing role of automation and other margin levers are also critical factors, in our view.

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