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Sustained demand tailwind to drive growth in 1QFY22

Outlook to remain intact in FY22

* We expect a median USD organic growth of 3.3% CC QoQ in 1QFY22 for our IT Services coverage universe. Despite a high base effect in 2HFY21, a strong demand environment and deal wins should result in continued strength across largecap and midcap IT companies (with a few exceptions).

* We expect largecap IT companies to report organic revenue growth of 2.1-3.9% QoQ CC, while the same for midcaps (excluding CYL, which will decline due to non-IT DLM business seasonality) should have a wider band of 2.8-6.3% QoQ.

* We expect commentary with regard to FY22 to remain constructive, with firms maintaining their double-digit revenue growth guidance. We also expect better clarity from companies like INFO, HCLT, and LTTS, which highlighted COVIDrelated uncertainty in their outlook in 4QFY21. We expect INFO to raise its FY22 revenue growth guidance on the back of a strong 1Q performance, while a revised capital allocation policy from HCLT can be a positive development.

* Recent commentary from industry peer ACN points to a better than expected demand environment. With strong deal signings expected during 1QFY22, the outlook on a seasonally strong 2Q should also be positive.

INFO/MTCL to lead QoQ revenue growth across largecap/midcap IT space

* We expect INFO to lead the growth in largecaps at 3.9% QoQ CC. This will be followed by TCS (+3.8% QoQ CC) and WPRO (+3.4% QoQ organic and 9% QoQ, including the CAPCO acquisition). HCLT/TECHM is expected to grow at 2.4%/2.1% QoQ, with TECHM benefitting from a 100bp inorganic component.

* Among midcap IT, we expect upbeat revenue traction, with the exception of CYL, which will decline by 4% QoQ, led by DLM seasonality and the impact of COVID-19 on the workforce during 1QFY22. MTCL should lead the pack with 6.3% QoQ growth, aided by deal ramp ups and growth momentum in both its top client and top 2-10 clients. We also expect PSYS and MPHL (Direct business) to deliver a strong performance in 1QFY22 by growing above 5% QoQ.

Supply-side issues a key headwind for margins

* We expect a dip in margins for most IT Services companies, led by a second wage hike and an increase in attrition/hiring. We expect wage hikes to be in the 100-350bp range for large/midcap IT companies.

* While skill specific cost has increased in the market, we expect companies to try to right size their pyramids in order to offset this increase.

* We believe largecap IT companies are better placed to absorb the supply pressure, given their capabilities on training employees in newer skills.

* We expect a 60bp aggregate sequential EBIT margin dip for largecap IT players, while the midcap universe should see a contraction of 110bp.

Expect strong PAT growth

* We expect our IT coverage universe to deliver strong PAT growth (25% YoY and 5% QoQ). TCS/INFO is expected to report a PAT growth of 33%/29% YoY. PAT for WPRO/HCLT will be subdued on account of a dip/flattish margin due to the CAPCO acquisition/higher employee cost.

* Midcap IT is expected to report strong PAT growth (31% YoY and 5% QoQ). This is driven by an 180bp YoY EBIT margin expansion (aggregate midcap).

* LTTS/PSYS/MTCL should continue their high PAT growth on expected superior operating performance

Valuation and view:

Prefer INFO/HCLT/LTTS/CYL/ZENT

* While the sector valuation remains elevated, we remain positive as double-digit topline growth in the medium term should support these valuations, led by: 1) larger deals on a full-scale Digital transformation, 2) increased volumes on cost takeout deals, and 3) higher spend on Cloud migration by large corporates.

* Strong sequential growth and the expectation of a lucrative guidance for FY22 should help sustain the rally in IT stocks, despite their premium valuations.

* We continue with our bottom-up stance for sectorial picks. Among largecap players, we like INFO and HCLT. We expect INFO to deliver top quartile growth, backed by strong deal wins (USD14b in FY21, up 56% YoY), justifying its premium valuation. HCLT will receive dual benefit from massive Cloud adoption, given its resilient expertise in IMS and gradual pickup in P&P, led by its ability to transform and renovate legacy products.

* In the midcap space, we prefer LTTS, MPHL, CYL, and ZENT. We expect LTTS to deliver strong growth (on a lower base) for FY22E, led by a recovery in the ER&D industry. We expect a recovery in CYL on stabilization in the Aerospace vertical and increasing ER&D spends. ZENT remains a tactical play, with an expected business recovery on management change and the adoption of a new strategy.

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