Published on 4/01/2018 4:26:16 PM | Source: Motilal Oswal Securities Ltd
Technology - Hope beyond seasonality - Motilal Oswal
Hope beyond seasonality
Faces the same-old policy overhang
New Year, same-old duel
* Commentaries around Digital-led revenue momentum have been the key highlight in a quarter of muted activity, raising hopes of a revenue growth recovery in CY18. Increasing base of new technology revenues aiding credible references, industrialization of Digital, and expectations of higher investments by US companies post tax cuts all favorably feed to the recovery theory.
* However, the industry has not been spared from policy overhangs, which continue to be closely monitored. The BEAT clause in the US tax bill has created uncertainty around companies operating under the subsidiary model with material transfer pricing (TCS, HCLT, CTSH and Captives). Also, the H.R.170 bill that primarily affects ‘H-1B dependent’ companies passed the House Judiciary Committee in November – it defines dependent companies as those where H-1B workers account for more than 20% of the workforce.
Expect muted 3Q growth bar exceptions…
* Seasonality will sit on top of a fairly muted year for Indian IT, weighing on the sector’s revenue performance in 3QFY18. We expect LTI to buck the trends and report 3.2% revenue growth QoQ, following its outlook of a better 2H as deals ramp up. PSYS should follow with seasonality in its IBM IoT deal, driving our expectation of 3.3% QoQ growth in revenues.
* We expect top-tier companies to grow 0.9%-2.5% QoQ in the quarter, led by TECHM. Among the remaining tier-II universe, CYL may witness some revenue decline due to a combination of furloughs and lumpiness in its design-led manufacturing segment.
…direction of the currency does not auger favorably either
* Strengthening of the INR v/s the USD resumed toward the end of the quarter. While average v/s 2QFY18 has not changed much, the USD now is below INR64, and the direction poses a risk to forward earnings. We have re-based our earnings for FY19E and FY20E to INR65.5 and INR66.5, respectively. Crosscurrency impacts remain minimal this quarter, implying a favorable effect on dollar revenue growth YoY basis 1H movements.
* We expect the margins performance to vary as wage hikes become due this quarter for a few companies. However, both PSYS and MPHL have cited expectations of revenue growth offsetting the impact from salary increases. We expect margins to expand at LTI and TECHM too, having fallen sharply in the earlier quarters. Revenue pressures at CYL will lead to a slight decline in 3Q profitability.
Commentaries of budget trends will be key
* We expect this year – like the last one – to begin with commentaries of benign expectations around clients’ spending trends in CY18. Hopes of a back-ended recovery in BFSI spend failed to materialize in CY17, and we do not expect cheers to a similar outlook this time around. Watch out for expectations of strong growth in 1HFY19.
* After an all-round margin surprise by the industry in 2Q, watch out for the sustenance and guidance around profitability going forward, and also comments on realization. Amid a strengthening INR, midcap IT’s resolve to maintain/expand margins will be tested.
* Key events to watch out:  CTSH’s CY18 revenue growth guidance,  comments on CY18 budgets,  WPRO’s 4Q guidance (after talks of convergence with industry),  comments from the new INFY CEO, and  TCS’ commentary on BFSI and Retail.
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