June’17 quarter preview: INR appreciation adding insult to injury
* We expect 1.5-2.5% QoQ revenue growth in constant currency terms in Jun’17 quarter for Tier I IT services players with Wipro being the only exception (de-growth of about 1%).
* Sharp INR appreciation against US$ of about 3% QoQ would impact the reported INR performance across players negating the operating growth and cross currency tailwinds. We expect impact of about 50bps-180bps on operating profits across vendors on account of adverse currency movement, visa charges and wage hikes in select cases.
* INR has been depreciating against US$ for last six fiscal and has been one of the biggest margin lever source for the IT vendors. In FY11, a 3.5% INR appreciation coincided with 50-200bps earnings decline for Tier I vendors despite topline growth of 15-30%. In current scenario this movement may lead to downward revisions of estimates in earnings.
* Prefer names such as Mindtree, Mphasis, LTI and Tech Mahindra with expected earnings growth acceleration in the current year.
Slow start to the year
Tier I IT should report a 1.5-2.5% QoQ revenue growth in Jun’17 quarter in constant currency terms with Wipro being on the only exception (-1% QoQ revenue growth). The growth rates are lower by Q1 average rates (Q1FY18 at 2.2% as compared for Q1FY17 average was 3.2%, Q1FY16 average was 2.6%) as most companies are guiding for a hopeful recovery in second half of the year. We believe the sustenance on pricing would be crucial for companies to achieve their growth outlook for the year (management are highlighting negative news flow around pricing pressure in all major rebid deals). We expect 25%+ yoy growth in the Digital revenues across vendors for them to achieve our estimates and would be important data to monitor in the earnings.
Prefer names that would see growth acceleration
We believe given the tectonic shift in the sector, stocks with growth acceleration would be relatively immune to situation and would attract significant premium over peers. We believe Mindtree, Mphasis, L&T Infotech and Tech Mahindra qualify on these parameters and are our preferred picks in the sector. We believe that the recent upmove on generous dividend (cash and stock) and gradual correction post the INR appreciation has resulted in short term price volatility and lead to select change in our stock ratings – Wipro (downgraded to Reduce), Mindtree (downgraded to Hold), Mphasis (Upgraded to Hold) and NIIT Tech (downgraded to Reduce)
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