Currency Fluctuations to Add to the Woes
We expect the IT firms under our coverage universe to post a combined 2.2% QoQ rise in USD revenue in 1QFY18. We expect the Top-5 IT firms to post 0-3% QoQ USD revenue growth in reported terms (0-2% in CC terms), with Tech Mahindra (TechM)and HCL Tech (HCLT) to lead the show. Mid-sized firms will see variation, with Mindtree and Cyient likely to lead (4.6% and 2.8% QoQ USD revenue growth, respectively). A positive in 1QFY18 is favourable cross-currency movements, with the USD depreciating against the EUR and GBP by ~3%, which will positively impact reported USD growth numbers by 30-90bps. However, the USD also depreciated against the INR by~4% QoQ, which will adversely affect reported INR numbers and EBITDA margins by~80-100bps.
The IT sector is already facing significant headwinds and disruptive trends, and INR appreciation will further exacerbate the scenario.The IT Industry body, NASSCOM has projected a 7-8% growth in IT-BPO exports in FY18, with the announcement coming as late as June 22 this time vs. the normal practice of providing industry growth guidance in February, owing to global uncertainty. Thus, in addition to the current issues faced by the industry, with revenue and profit growth hard to come by, INR appreciation makes it even more challenging for the sector.
On margin front,we expect most firms to post 60-160bps sequential decline owing to appreciation, growth challenges and higher visa cost. Within our coverage universe, Wipro, TechM and Mindtree are likely to post improved margins owing to growth and lack of anyone-time cost. We expect continuous focus on levers like utilisation and cost efficiencies. On YoY comparison,barring Infosys, Wipro and Hexaware, all IT firms are likely to see lower margins in the range of 50-620bps.
We would watch for sustainable margin outlook and IT budget trend. Focus on return of cash to shareholders is also a theme playing out, with TCS, HCLT, Hexaware, Mindtree and eClerx all resorting to share buy backs in order to make better usage of their cash balances. We continue to believe Indian IT is a bottom-up sector and judicious stock picking will play a key role in driving alpha.
Our Top Picks: HCLT among the large-caps, Cyient and Sonata among the mid-caps.
Revenue Growth to Remain Subdued
We expect 2.2% sequential revenue growth for the IT firms under our coverage universe, while YoY growth is likely to remain subdued at 5.9%, partly owing to adverse cross-currency impact and increasing competitive intensity and pricing pressure. Favourable cross-currency movements (GBP, EUR depreciated by ~3% QoQ vs. USD) will have a positive impact to the tune of 30-90bps on reported USD growth numbers. However, this will be offset by INR appreciation vis-à-visUSD to the tune of~4% QoQ, leading to reported INR growth numbers coming in at -6% to +1% QoQ. Company-wise, we expect TechM and HCLT to outperform their peers among top-tier IT pack (+4% and 3.1% QoQ, respectively), while Mindtree and Cyient are likely to outperform the mid-sized firms (+4.6% and 2.8% QoQ, respectively). Wipro, KPIT Technologies and eClerx are likely to under-perform their peers. We believe factors like SMAC, challenging macro scenario, high competitive intensity and pricing pressure will sustain and impede growth over the next few quarters as well.
Margins to Weaken on Currency Woes, Higher VisaCost
Margins are likely to see 60-160bps sequential decline owing to INR appreciation and higher visa cost. On YoY basis – barring Infosys, Wipro and Hexaware – margins would see across-the-board decline in the range of 50-620bps. Five out of the top and mid-tier IT firms under our coverage will report an absolute YoY decline in EBIT, ranging between 2-20%. Client specific issues, challenging macro environment and vertical/ service specific headwinds would continue to impact profitability.
Focus on Guidance Maintenance, Cash Return
In our view, the street’s attention will be focused on revenue guidance/qualitative outlook and return of cash to shareholders. We believe maintaining status quo in current guidance/qualitative outlook and incremental progress on return of cash to shareholders will be viewed as positives. The business environment remains challenged with protectionism in key geographies like the US, UK and Australia continuing to be a key concern, while disruptive trends, especially SMAC are likely to continue to erode IT firms’ incremental prospects. In this context, maintaining margins within a narrow band at least until revenue growth sees a sustainable up-tick assumes importance. The increasing role of automation and other margin levers are critical in our view.
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