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Revenue growth for most IT companies under our coverage was healthy in CC terms in Q2FY23. Growth rate ranged between 2.9-4.1% QoQ CC for tier-1 companies, 1.6-7.2% QoQ CC for tier-2 companies, and 4.5-10% QoQ CC for ER&D companies. We note that tier-2 IT continues to outperform tier-1 on revenue growth. However, the extent of outperformance has reduced over past two quarters. USD growth was weak due to cross-currency headwinds of 100-280bps QoQ led by depreciation of GBP/EUR vs USD. Cross-currency headwinds are likely to impact USD revenue in next two quarters as well.

Deal win TCV remained flattish QoQ, but was healthy YoY for most companies. Infosys and Mindtree reported strong YoY growth in deal TCV. Though companies reported healthy TCVs in Q2FY23, management commentaries suggest clients are prioritising spends towards quicker-RoI projects and have greater focus on cost optimisation. Areas of weak demand widened further in Q2FY23. Infosys management pointed to emerging weakness in the telecom and hi-tech verticals, especially in discretionary spends apart from the slowing demand in retail and mortgage called out in the previous quarter (Q1FY23). Additionally, moderation in hiring across the IT pack for second consecutive quarter also implies that companies in the sector are baking-in demand slowdown in H2FY23 and FY24.

Growth in Europe was healthy for Wipro, HCLT, LTI, Coforge, Persistent despite macro concerns in Q2FY23. However, management commentaries suggest that IT spending (discretionary) in Europe is likely to reduce in H2FY23 due to the uncertain macroenvironment and tough winter. For example, TCS management indicated that while book-to-bill has improved for TCS in Europe on QoQ basis, the timeline to convert to qualified pipeline has elongated implying potential delay in deal conversions in next few quarters.

EBIT margins for tier-1 IT improved by ~16-150bps QoQ, but contracted ~120-380bps YoY and are still below pre-covid levels. Margin tailwinds were: 1) revenue growth helping absorb the impact of wage hikes rolled out in Q1FY23, 2) employee pyramid optimisation, 3) currency benefits, and 4) reduced sub-con costs. EBIT margins were flat QoQ for most tier-2 IT players. We expect margins to improve from Q3FY23 as premium paid for backfilling attrition reduces and utilisation improves as freshers become billable.

IT companies have either maintained or increased their lower end of revenue guidance. Infosys management revised its revenue growth guidance to 15-16% YoY CC vs 14-16% YoY CC earlier. HCLT management revised the same to 13.5-14.5% from the earlier 12- 14% YoY. However, given healthy revenue growth for Infosys and HCLT in H1FY23, the guidance implies soft revenue growth in H2FY23 as companies factor-in furloughs in line with historical trend and slowdown in spending due to the challenging macro.

We have increased our USD/INR FX rate assumption to 82.5 for H2FY23 and FY24 vs earlier ~81.5-82 leading to marginal increase of ~0.6% in FY24 EPS across IT pack. We continue to prefer stocks that are less vulnerable to slowdown and have the potential to continue gaining market share even in business downturns. We continue to prefer large-caps (HCLT>Infy>TCS>TechM) over midcaps. Growth differential between large caps and mid-caps is likely to reduce from coming quarters in our view, while street is still giving higher growth multiple to midcap IT. Cyient is our top pick in small cap given attractive valuations, potential turnaround in performance and divestment of DLM to improve capital allocation and management bandwidth towards core business.

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