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Expect COVID-19 uncertainty to overshadow 4Q results
Low expectations due to partial disruption during the quarter
Growth/margins to be impacted across most companies
* We expect MOFSL coverage universe to post revenue (USD) / EBIT (INR) / PAT to grow 6%/4%/-2% YoY in 4Q.
* On a sequential basis, Tier I revenue should move in the range of (0.5)%-1.3% (CC) and (1.7)%-0.6% (USD) with HCLT/TechM leading/lagging the pack.
* Across Tier II, revenue should move in the range of (2.5)%-3% (CC) and (3.2)%- 2.5% (USD) with LTI/Cyient leading/lagging the group.
* While we expect EBIT margins of Tier I to contract to the tune of 20-40bp (QoQ), margins of our Tier II coverage should move in the range of (80)-420bp.
* Second half of 4QFY20 witnessed varying levels of COVID-19 disruption across most of the core markets of IT companies like the US, Europe and even India.
* Most of our coverage companies did a reasonable job in controlling the damage by resorting to options like ‘work from home’.
* However, it should be noted that not all service offerings are amenable to be delivered from home for a variety of reasons. In conjunction with lower productivity, both billing and utilizations in 4Q should witness an impact.
Expect guidance on FY21 growth/margins to be delayed
* Given the unprecedented level of uncertainty around the global macro and the multiple moving parts, visibility on near-term growth/profitability is challenged.
* Accordingly, we expect companies like Infosys/HCLT to delay their FY21 growth/margin guidance to the subsequent quarters.
* Even if they were to guide, these guidance bands will likely be wider than usual and subject to sharp revisions later on as clients relook at their IT budgets.
* In that context, deal signings during 4Q (especially in the second half) will likely be a key area of investor focus as it is the latest available proxy for demand.
* In addition, qualitative cues around the adaptability of different companies to the new work paradigm will be the key thing to watch out for.
* This may include their ability for end-to-end digitization of key processes like deal signings, employee onboarding and deal ramp ups.
* Commentary around expected pressure on pricing, INR depreciation benefit and receivables will be another important area of investor focus.
Expect near-term uncertainty due to COVID-19; prefer INFO, HCLT and LTI
* Given the continuously evolving nature of COVID-19, demand, supply, pricing and receivable uncertainties should remain in the near term.
* Negative news flow around the sector may likely continue given the seriousness of COVID-19 situation in the core geographies like the US, UK and EU.
* In that backdrop, we expect the stocks to trade below their long-time cross cycle average P/E multiples until the time this uncertainty is behind.
* Despite the near-term uncertainty, we continue to prefer Infosys and HCLT among large caps, and LTI among Tier II. This is attributable to their historical track record in adapting to business challenges/technology change cycles.
* Besides, we find the P/E multiples of these stocks to be meaningfully lower than their historical averages, offering adequate margin of safety.
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