IGI Logo

Expect strong 4QFY21 and FY22 outlook despite cost pressures

Revenue growth to stay at multi-year highs in 4QFY21

* We expect Tier I IT companies to report growth between 2.5% and 3.4% QoQ CC (barring TECHM), their strongest 4QFY21 performance in the last five years. Tier II IT should deliver 3.3-5.2% QoQ CC growth (except MPHL and ZENT).

* Growth in 4QFY21 continues to be driven by a supportive demand environment and large deal wins. We expect our coverage universe to deliver revenue (USD)/adjusted EBIT/PAT growth of 8%/19.7%/16.2% YoY in 4QFY21.

* Early indicators like fresh high order bookings from industry peer Accenture in its Feb’21 earnings (link to the report) also point to an unprecedented demand for tech services, which we expect to reflect in the deal momentum in 4QFY21. Expect double-digit FY22E guidance for the sector

* The strong topline growth in 2Q/3QFY21 sets up the industry for robust doubledigit growth in FY22E.

* We expect INFO and HCLT to guide at early to mid-teen revenue growth in FY22E among Tier I IT. Among Tier II IT, managements should indicate mid-teen revenue growth, driven by a strong exit in FY21 and good deal pipeline.

* FY22E should continue to see large deal wins, aided by continued spends on Cloud and acceleration in decision making as COVID-19 vaccination ramps up. We also expect more captive deals to be available to Tier I IT companies.

* We expect managements to highlight plans to add to their workforce as higher demand and elevated utilization should lead to the strongest employee addition in recent past (our estimates suggest Tier I IT is adding ~2x of FY21 net additions). TCS to lead sequential revenue growth across Tier I, COFORGE in Tier II

* In Tier I IT, we expect strong sequential growth trends across all companies baring TECHM, which will have a soft quarter on account of lower deal wins. Growth in TCS/INFO will be driven by a ramp up in large deal wins such as Postbank, Prudential, Daimler, etc. We expect Tier I IT to grow at 3.6% QoQ in USD terms, helped by cross currency tailwinds.

* Upbeat traction in Tier II IT will continue. We expect COFORGE and LTTS to lead the growth trends in the Midcap IT space. Most companies should report upward of 4% QoQ USD growth during 4QFY21. Exceptions will be MPHL – led by the expectation of double-digit sequential decline in the DXC business, and ZENT – led by weakness in a top account and project closures in the DFS business.

* We expect Tier I IT companies to be a key beneficiary of rising Cloud spend and Digital transformation initiatives by corporates. Rising deal sizes and central level transformations should provide a thrust to larger IT Services companies. Wage hike and attrition to take a toll on margins

* We expect a dip in margins for most IT Services companies led by partial wage hikes and increase in attrition levels. We expect wage hikes to be in the 100- 200bp/200-300bp range for Tier I/II companies.

* We also expect gradual normalization in utilization levels as we expect a pick-up in fresher hiring by IT Services companies.

* Increasing attrition levels in the industry can be verified by: 1) announcement of a second wage hike by TCS, 2) 300bp sequential increase in Accenture attrition levels, and 3) a staggering 33% increase in hiring activity (driven by IT Services companies) on Naukri.com for Feb’21.

* Sequential EBIT margins of Tier I players should decline by 80bp, largely driven by expectations of a 400bp decline in HCLT’s margin on a wage hike and onetime bonus payment. Tier II companies should see an aggregate decline in margins by 60bp QoQ.

* Normalization of utilization and increase in attrition levels poses a near to medium term risks to our margin estimates.

Valuation and view: Prefer INFO/HCLT/LTTS/CYL

* While the sector trades at a 39% premium to its 10-year average multiple, we remain positive as we expect the sector to sustain double-digit topline growth in the medium term, led by: 1) larger deals on a full-scale Digital transformation, 2) tail of projects steered by increased focus on workplace management, and 3) higher spend on Cloud migration by large corporates.

* Strong QoQ growth (4% on an average) and expectation of lucrative guidance for FY22 should help sustain the rally in IT stocks despite their premium valuations.

* We continue with our bottom-up stance for sectorial picks. Among Tier I players, we like INFO and HCLT. We expect INFO to deliver a top quartile growth backed by strong deal wins (USD12b in 9MFY21, up 63% YoY), justifying its premium valuation. HCLT will receive the dual benefit from massive Cloud adoption, given its resilient expertise in IMS and strong pickup in P&P, led by its ability to transform and renovate legacy products. From the Tier II pack, we prefer LTTS and CYL. We expect LTTS to deliver strong growth (on lower base) for FY22E, led by a recovery in the ER&D industry. We expect a recovery in CYL on stabilization in the Aerospace vertical and increasing ER&D spends.

To Read Complete Report & Disclaimer Click Here

For More Motilal Oswal Securities Ltd Disclaimer http://www.motilaloswal.com/MOSLdisclaimer/disclaimer.html SEBI Registration number is INH000000412

Above views are of the author and not of the website kindly read disclaimer