01-03-2023 02:52 PM | Source: Emkay Global Financial Services Ltd
Information Technology Sector Update - Q3FY23 preview: Soft quarter; Margin recovery to continue By Emkay Global Services
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Q3FY23 preview: Soft quarter; Margin recovery to continue

? Revenue growth momentum is likely to moderate in Q3 due to furloughs, lower number of working days, deferred spending by few clients, and increased cautiousness among clients amid macro uncertainties. We expect revenue growth of 0.8-3.7% CC QoQ for Tier-1 companies and of -0.4% to 3.4% for mid-cap companies

? Except for LTIM, EBITM is expected to expand by 20-100bps QoQ for Tier-1 companies and 20-50bps for mid-cap companies on account of flattening employee pyramid, optimization in subcontracting costs, operating efficiencies, and rupee depreciation.

? We reckon INFO and HCLT will retain their guidance of 15-16% CC YoY revenue growth/21-22% EBITM and 13.5-14.5% CC revenue growth/18-19% EBITM for FY23, respectively. Wipro is expected to guide for 1-3% CC QoQ revenue growth for Q4

? Nifty IT index gained ~6% in the last 3M, largely in line with the broader market indices. Risks of recession and potential cut in FY24 revenue remain; however, margin resilience and weak rupee would limit earnings cut. We roll forward our TP to Dec-23 across our coverage universe. Our pecking order is WPRO, INFO, TECHM, HCLT, and TCS among Tier-1 players, and Zomato, MPHL, BSOFT, FSOL, and PSYS among mid-caps.

Seasonal factors and macro uncertainties to weigh on growth: We expect revenue growth momentum to moderate in Q3 on account of furloughs, lower number of working days, deferred spending by few clients, and increased cautiousness among clients amid macro uncertainties and high inflationary environment. Within our coverage, we expect CC revenue growth of 0.8% to 3.7% for tier-1 companies (cross-currency impact of 20-50bps on reported USD revenue) and of -0.4% to 3.4% for mid-cap firms (cross-currency impact of 10-30bps on reported USD revenue). We expect the usual seasonality in H2 growth to be amplified by slower decision making and weak discretionary spending due to macro uncertainties. We expect INFO to retain its 15-16% CC revenue growth and 21-22% EBITM for FY23. HCLT is also likely to retain its 13.5-14.5% CC revenue growth and 18- 19% EBITM guidance. Wipro is expected to guide 1-3% CC QoQ revenue growth for Q4FY23. We expect COFORGE to increase its CC revenue growth guidance to at least 21% (currently at least 20%) while retaining its adjusted EBITDAM guidance of 18.5-19% for FY23. Deal intake is likely to reflect the elongated sales cycle and is more skewed towards cost efficiency and takeout deals.

Rupee depreciation and moderation in attrition to help improve margin sequentially: Except for LTIM, We expect EBITM to expand by 20-100 bps sequentially for Tier-1 companies and 20- 50bps for Tier-2 companies on account of operating efficiencies, employee pyramid rationalization, moderation in attrition, and rupee depreciation. LTIM margin is expected to be impacted by one-off costs related to merger integration. We believe EBITM has a further scope of upside in Q4FY23 for most companies on account of flattening employee pyramid, better utilization, sub-con optimization, and weak rupee.

Key monitorables: 1) CY23 IT budget; 2) FY23 revenue growth/margin guidance; 3) deferment or cancellation of projects due to macro uncertainties, high inflation, and supply-chain disruptions; 4) management commentary on the changing nature of deals (cost takeouts vs. business transformation) and potential impact on tech spending from high inflation and economic slowdown; 5) demand trends in key verticals such as BFSI, retail, manufacturing, and communications; 6) segments exhibiting weak demand trends; 7) deal intake/pipeline; 8) pricing environment; and 9) attrition.

 

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