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We hosted our 5th ‘Tech’ Investor forum with 20 corporates/experts participating in the event (virtual). The participants represented the full spectrum: (1) Large-cap IT services (TCS, Infosys, Wipro, Tech Mahindra, L&T Infotech), (2) IT/ER&D midcaps & small caps (Mphasis, L&T Technology, Mindtree, Tata Elxsi, Happiest Minds, Zensar, Sonata, Intellect and Mastek), (3) Staffing (Teamlease) and (4) Tech industry experts (IBM, Capgemini, Salesforce, ISG, and Captive expert ANSR). The commentary across companies/experts indicated a continuation of multi-year industry tailwind (cloud acceleration) and optimism around the sector hitting and sustaining double-digit growth rate was validated.

Key demand trends are: (1) large deal wins driven by accelerated modernisation/transformation agenda of enterprises, (2) strong deal funnel despite large deal bookings, (3) greater alignment of the industry with hyperscalers/SaaS majors, (4) cloud migration (only ~30-35% of the workload on the cloud), (5) better growth distribution across verticals (Manufacturing, ENU and Retail & CPG), and (6) rising competitive advantage/gains of Indian IT in large deals.

The supply-side dynamics continue to be favourable. Factors such as (1) higher offshoring/ lower sub-contracting is keeping cost of delivery stable, (2) better demand fulfilment is supported by large scale reskilling and training efforts and (3) efficiencies from lower overheads will keep margins steady, despite some headwinds due to return in discretionary (partial) & deferrals. While attrition can spike in the medium term and utilisation levels can moderate, risk to margin is low. Margin expansion in the sector (320bps since the pre-pandemic level) was a culmination of the above trends and we see those sustaining.

Key highlights

The industry experts/companies highlighted the following: (1) demand environment improving further, larger vendors will continue to benefit from scale posing higher hurdle rate for mid-tiers; (2) supply-side constraints are only in highly-skilled areas (attrition variance within the companies can increase); (3) lower services multiplier in SaaS as compared to on-premise but the overall opportunity provides a big ‘net’ opportunity; (4) pandemic has increased the acceptance of global delivery model, with seamless progression into virtual framework of sales, knowledge transfer and execution; and (5) high efficiencies in captives on multiple parameters.

Our view

We expect the IT sector revenue to grow at 14.4/10.8% (in USD terms) for FY22/23E with mid-tier IT growth to come in at 15.1/12.5%. We expect a margin expansion of ~55ps over FY21-23E (10/45 bps expansion in FY22/23E), following a 220bps expansion in FY21, leading to ~17% EPS CAGR over FY21-23E. We remain higher than consensus (HSIE EPS is ~6% ahead for FY23E) and expect the outperformance to continue. We increase multiples for Mindtree/Cyient/Zensar/Sonata and roll forward to Mar-23E for our coverage universe. Earnings for Wipro is revised downwards by 6.5/3.9% due to acquisition impact while we have increased estimates for Mindtree/Zensar/Sonata/Teamlease. We prefer INFY, HCLT, Persistent and Sonata.

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