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Good margin defence; weakness in deal TCVs

Infosys’ revenue was largely in-line, but Wipro and Mindtree surprised – the latter was also aided by the one-time unlock of physical retail in UK. While Wipro’s growth was relatively broad based, Infosys and Mindtree were more concentrated within a few verticals. Lukewarm growth in key verticals like financial services, retail for Infosys / Wipro and revenue stagnancy in top account for Mindtree were noteworthy trends. Despite partial wage hikes and supply side cost pressures, all three companies reported impressive margin defence. Further shift of effort mix towards offshore and step up in utilisation helped, a trend which is unlikely to sustain as travel / office resumes. Attrition increased sharply, by 400-620bps QoQ (LTM), with Infosys / Mindtree being the most / least impacted. This is guided to increase / stay elevated for at least another 2-3 quarters. Both revenue / margin guidance for Infosys / Wipro were in-line with expectations.

Normal seasonality for December quarter is expected with Infosys and Mindtree hinting at the possibility of furloughs. Like in case of TCS, TCV of deal wins witnessed a downward trend (QoQ) for all the three. For Infosys, which reports the split, continued skew towards renewals (65%) is concerning. While ACVs continued to be strong, expectations of multi-year upcycle / durable demand (base case expectation of consensus) calls for higher share of longer duration / large-sized deals, in our view. Our earnings for these three companies reflect ~2-6% upgrades. Barring a few exceptions (e.g. Infosys, LTI, Mphasis), we expect growth rate of the industry to revert to pre-covid levels as the base effect normalises and one-off distortions (e.g. retail unlock boost in Mindtree) cease in the post-covid equilibrium. Supply-side pressures in conjunction with impending cost headwinds like travel / office resumption should translate into largely lower than pre-covid margins.

Overheated and life-time high valuations of many stocks more than capture the near-term strength / predictability in earnings. For instance, Mindtree is now trading at 47x 1-year forward P/E (consensus) vs pre-covid long term average of 15x. Similarly, Wipro is now trading at 29x vs pre-covid long term average of 15x. Even as Infosys too re-rated significantly (now at 30x vs historical average of 17x), we believe this is more sustainable given the growth leadership position the company regained and relatively more durable demand. Infosys remains our TOP BUY. Given the sharp rally in the stock price over the previous 3 months (+61% v/s 15% in Nifty mid-cap) in anticipation of strong Q2, we see limited upside in Mindtree (HOLD).

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