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Revenue growth likely to be weak

 The growth of the IT services industry is expected to remain weak in 2QFY24, as macroeconomic uncertainty continues to weigh on discretionary spending. While the industry has witnessed an uptick in order inflow over the past two months with a focus on cost efficiency, the slowdown in project-based business is expected to hamper overall industry growth, even though Q2 is traditionally a robust season for the sector. Our IT Services coverage universe should report a median revenue growth of 1.5% QoQ/5.7% YoY in 2QFY24. This growth rate is among the slowest observed over the last decade, despite a marginal impact from FX fluctuations. However, a focus on cost-control (led by deferrals in wage hikes) measures should lead to margin improvement in 2Q, and help the industry deliver 3.7%/4.1% QoQ growth in EBIT/PAT, respectively. We estimate USD YoY Revenue/INR EBIT/INR PAT to grow at 3.6%/5.7%/6.6% in 2Q.

* The weakness seen in Q1 should continue across the board with no meaningful signs of recovery or deterioration. We expect Tier 2 IT companies to see further moderation in growth, which can lead to narrowing in the valuation gap (1-year forward P/E) between Tier 1 (median 22x) and Tier 2 (median 27x). Deal TCVs should look attractive with recent mega deal wins for selective names. We expect collective deal TCV (Tier1 + Tier 2) growth to stay inline or improve sequentially vs Q1. Q1 reported 1% QoQ decline in deal TCV. However, with elongated ramp-up, these deals will have limited contribution in the second quarter.

* In the face of increasing inflation and declining consumer spending, sectors such as BFSI, Retail, Hi-Tech, and Communication continue to show signs of softness. The growth for BFSI and Retail (IT pack MOFSL) has joined a negative trajectory with 1.2% and 0.4% decline (median USD growth QoQ) in Q1, we expect these two verticals to remain weak in Q2. Additionally, Manufacturing joined weaker growth trajectory with 1.0% QoQ median growth in Q1, affecting specific companies within the sector. On the other hand, there is no sign of demand recovery in the key geographies (US and Europe) with the majority of the clients maintaining caution and pausing contracts that are non-critical to them.

* As spending patterns have shifted toward cost reduction and efficiency-focused initiatives, deal components targeting these essential areas have experienced increased momentum, supporting overall growth. However, the worsening macroeconomic conditions are tightening spends on transformational initiatives and non-critical multi-year projects. Additionally, the adverse macro environment is blurring the near-term visibility of recovery and resumption of spends on discretionary areas.

* We expect revenue growth of Tier-I companies to be in the range of -1.2% to +3.6% QoQ CC. Revenue of Tier-II players are expected to grow to the tune of +0.4% to +3.2% QoQ in CC terms