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Encore

Following the ‘decade-best’ 3Q growth, we expect an encore with the sector (coverage universe) set to post decade-best 4Q sequential performance. The pandemic has evidently accelerated the digital transformation agenda and key lead indicators remain positive. Over the 5% QoQ posted in 3QFY21 (and 6% in 2Q), we expect the sector to deliver 3.9% QoQ. Ramp-up of large deals, broad-based momentum and positive cross currency will support growth. While growth print is expected to be homogenously positive, divergence in operational performance dashboard is driven by (1) wage increase schedule (deferred earlier), (2) accelerated pace of hiring resulting in varying trends in utilisation/attrition (while offshoring continues to be strong). Recent commentary on the sector at our conference (IT sector: onwards and upwards) was buoyant on demand trends (deal funnel, bookings, cloud opportunity, large deals) as well as sustaining supply-side scenario (training efforts, lower sub-contracting dependence, offshore delivery), mitigating some rise/drop in attrition/utilisation. Deal activity (TCS-Vodafone/ThreeUK/Skanska; INFY-Siemens/Toyota/ Newmont; HCLT-Airbus; WPRO & TECHM-Telefonica; Mindtree-Knauf) remained strong in 4Q with evidence of uptick in Manufacturing and Communication verticals. Read-through from global peers remains positive including Accenture’s outlook, Capgemini’s medium-term (CY25) growth outlook and GlobalLogic’s acquisition by Hitachi. The alignment with large cloud providers is improving and growth of SaaS, hyperscalers continues to be robust.

* Revenue outperformance led by TCS, INFY and ER&D companies: In 4QFY21E, we expect TCS and INFY to lead the growth at 3.5% QoQ CC each, supported by ramp-up of large deals (PBS, Prudential, Rolls Royce). HCLT/WPRO/TECHM are expected to post 2.5/2.7/1.0%. Within mid-tiers, ER&D is expected to post strong growth with TELX/LTTS/CYL at 6.5/5.0/3.0% QoQ (USD terms). MTCL and LTI are expected to post 4.5% and 4.3% QoQ, while ZENT will lag at -2.2% QoQ. In terms of margin, TCS is expected to outperform within tier-1s. ER&D companies are expected to outperform operationally too in 4Q within the mid-tier universe.

* Key monitorables: (1) Guidance: INFY/HCLT revenue/margin guidance for FY22, WPRO’s 1Q revenue guidance, LTTS’ FY22 revenue guidance; (2) Deal wins & TCV and deal pipeline; (3) Margin performance (scope for outperformance) and performance/outlook on cost of delivery (wage hike cycle for FY22, utilisation, hiring, attrition, offshoring, sub-contracting); (4) Trends in large deals (closure timelines, profitability) and pricing in digital; (5) Performance & outlook on key verticals; (6) Capital allocation (inorganic) stance in light of stronger cash generation (FY21E).

* Maintain positive stance: Our EPS estimate tweaks are largely due to USD-INR reset and our estimates remain ahead of consensus (~4% for FY23E). We selectively raise target multiples (PSYS, MTCL, MPHL, LTTS) to reflect high visibility/sustainability of growth. Despite the sector’s valuation at 1.5x historical multiples, we remain constructive and our preferred picks checks for (1) growth outperformance, (2) greater visibility of growth and (3) upside risk to base case. Our positive stance on the sector is premised on the longevity of high-growth (and strong BS) supported by multi-year industry tailwind from shift to cloud, increasing competitive advantage leading to continued market-share gains. Key risks remain macro recovery upending and unfavourable USD-INR. Preferred picks are Infosys, HCL Tech, Tata Elxsi and Persistent Systems.

Exchanges and Staffing

* Within exchanges, MCX is expected to post a 5.0% QoQ decline in revenue due to a 4.2% QoQ decline in ADTV, led by a decline in bullion volume. Energy/Metals volume has recovered by +5/7% QoQ but index derivative volumes were flat sequentially. Margins will contract 494bps QoQ to 43.3% due to non-linearity and wage increase. MCX volume growth has stagnated over the last two quarters and pickup in index derivative contracts is slower than expected.

* BSE witnessed recovery in its core business performance (cash volume up 50% QoQ) and cash market share recovered to 7.4% (+176bps QoQ). BSE market share in the derivative segment stood at 6.1%, where NSE is a dominant player. The net cash (excluding SGF and clearing cash) is ~70% of the market cap and the value of CDSL stake after 25% discount is INR 227/share. We maintain BUY with a target price of INR 750, based on 10x core FY23 PAT + net cash + CDSL stake.

* CDSL will continue its strong performance in 4Q with +6.1/53% QoQ/YoY growth. Transaction charges will continue to register healthy growth (2.7x in 9MFY21) led by market activity and pledge revenue. Annual issuer charges/online data charges (e-KYC)/IPO & corporate action will grow +5.2/2.0/6.0% QoQ. The EBITDA margin will expand by 73bps QoQ to 65.8% and PAT will increase 3.9 % QoQ to Rs 0.56bn. CDSL continues to gain BO account market share and has crossed 30mn accounts in the quarter. BO accounts grew ~50% YoY and CDSL’s market share stood at 59.8% (Feb-21) with 85% incremental market share.

* Within staffing, Teamlease will post a strong quarter with +6.0% QoQ growth in revenue, led by growth in core staffing (+6.4% QoQ). The growth is led by a gradual opening up of the economy and a strong recovery in NETAP additions (Manufacturing). Specialised staffing is expected to grow +1.4% QoQ led by a recovery in IT hiring and stability in Telecom staffing. The EBITDA margin will improve by 9bps QoQ to 2.0%, led by higher productivity, improving business mix (high-margin specialised staffing) and cost control initiatives.

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