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Expect decent revenue growth against elevated expectations

* 2QFY25 revenue growth likely to be decent but could disappoint elevated expectations: As we noted in our recent thematic report (Technology: Bounceback! Charting the path to revival for IT services), we are enthusiastic about a change in client spend behavior but believe that the recovery will be gradual and could be initially restricted to some pockets, e.g. US banking. In that context, while we expect decent revenue growth in 2Q, expectations are elevated and could lead to short-term disappointment. Healthcare and manufacturing segments would continue to shoulder the growth burden for the industry, in our view. That said, we are not too concerned about variance in revenue growth in 2Q and believe it should not lead to a meaningful change in estimates, sentiments, or valuations (short-term gyrations aside). The most important catalyst for the sector now would emerge after 3Q, when client budgets for CY25 would be finalized and the magnitude of changes in client behavior would become clearer. We expect aggregate revenue/EBIT/PAT to grow by 5.1/5.0/5.3% YoY (all in INR terms) for our coverage universe.

* We expect YoY revenue growth of ~5.5%/5.9%/4.9% for INFO/TCS/HCLT in FY25. Mid-tier companies should continue to do well though, especially companies with strong offerings in data engineering and ERP modernization and we expect their growth outperformance to be sustained over the medium term.

* Cross-currency impact in 2Q: On an average, we expect 30-60bp cross-currency tailwinds for our coverage companies on a sequential basis.

* Guidance: We expect INFO to upgrade its guidance in 2Q, in line with consensus estimates. We expect minimal risk of guidance downgrade for the sector overall.

* We expect revenue growth of Tier-I companies to be in the range of flat to +3.0% QoQ CC. Revenue growth for Tier-II players is expected to be in the range of flat to +4.5% QoQ CC.

* Margins for the sector are likely to be largely range-bound in 2Q as wage hikes have been deferred to 2HFY25: We expect margin declines for INFO (reversal of one-offs) and TCS (continued large deal ramp-up), which should be partly offset by the absence of visa costs and cost optimization benefits. Most companies, however, have deferred wage hikes to 3Q and beyond, which means 2HFY25 margins would see headwinds from wage hikes as well as furloughs. We believe FY25 will be a year of restrained wage hikes across the industry. Further, considering the demand recovery curve will be gradual, companies can be more measured about their hiring plans. This should lead to better margin defense in the short to medium term.

* Among Tier-I players, we prefer HCLT and LTIM for their strong capabilities in data engineering, ER&D offerings (HCLT) and ERP modernization, making them well-suited for pre-GenAI spending.

* For Tier-II players, our top picks are PSYS and COFORGE, both poised for strong performance. PSYS stands out for its focus on high-growth sectors like healthcare and BFS. Meanwhile, despite uncertainties related to the Cigniti integration, COFORGE is likely to realize cost synergies sooner than expected, which could lead to upside risk to our estimates.

Growth expectations across our coverage

* We expect INFO and TCS to report relatively robust 3.0% and 1.0% CC QoQ growth, respectively, whereas HCLT is anticipated to report flat growth in 2Q (~1% QoQ organic). TECHM and WIPRO could be flat QoQ as well. LTIM could report a relatively healthy 3% growth.

*  Among mid-tier companies, we expect PSYS to lead the pack with 4.5% QoQ revenue growth, driven by continued momentum in the healthcare vertical. COFORGE is also likely to have a strong quarter with 4.0% QoQ growth, while Mphasis is expected to grow 2% QoQ.

* We expect Cyient DET to report a soft quarter as well, potentially putting its FY25 guidance under risk. We are factoring in a modest cross-currency impact for most companies (~30-60bp positive impact).

Margins are expected to show varied performance

* We expect EBIT margins for TCS to slightly decline by 20bp QoQ, largely due to the BSNL deal ramp-up and investments made in talent development and training. For HCLT, margins might see a slight uptick, but could face headwinds in 2H as wage hikes come into the picture. For INFO, we expect margins to decline by 80bp as the reversal of one-offs and large deal investments will weigh on profitability. TECHM’s margins are expected to inch up by 50bp, whereas WIPRO should see a minor decline.

* Among mid-caps, we expect a mixed margin performance sequentially. COFORGE’s margins should be down ~100bp, primarily due to wage hike impact, whereas large deal ramp-ups and wage hikes will pressure margins, though optimization measures will help to offset this pressure for PSYS. MPHL’s margins are expected to remain range-bound, while LTTS should see a 90bp QoQ gain, driven by offshoring and a favorable pyramid structure.

We see uptick in demand, but in pockets; HCLT and LTIM our top picks

* Client spending behavior is showing positive trends, indicating a potential return of modernization and discretionary spending, albeit in some pockets.

* Among Tier-I players, we prefer HCLT and LTIM for their strong capabilities in data engineering, ER&D offerings (HCLT) and ERP modernization, making them well-suited for pre-GenAI spending. Their portfolio mix of discretionary and nondiscretionary businesses should also support growth in the current business environment.

* For Tier-II players, our top picks are PSYS and COFORGE, both poised for strong performance. PSYS benefits from its focus on high-growth sectors like BFS and healthcare. For COFORGE, despite uncertainties surrounding the Cigniti integration, we believe it can achieve cost synergies sooner than anticipated, presenting upside risk to our estimates.

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