We estimate the top five Indian IT players — Infosys, TECHM, HCLT, TCS and Wipro – would report organic revenue growth of 1.9–3.5% QoQ in constant currency (cc) in Q2FY20. However, a strengthening USD would pare 50–60bps of cc growth in our view. Barring TechM, we expect margins of the remaining four to rise by 50–90bps QoQ as most headwinds such as wage hikes and visa costs have blown over. A weak INR should also boost margins by 20–30bps QoQ. While revenue growth may still elude mid-caps, we expect them to get on the road to margin recovery this quarter. Healthy momentum in digital and robust deal pipeline across verticals are likely to underpin strong management commentaries. We will keep an eye out for:
i) increase in deal sizes and tenures in digital;
ii) demand commentary by industry, specifically BFSI and retail; and
iii) commentary on margin outlook for H2FY20.
Maintain ‘BUY’ on Infosys, TECHM and HCLT, and ‘HOLD’ on TCS and Wipro.
Stronger USD to overshadow revenue growth
Large deal-wins led by enterprise-wide adoption of digital are expected to drive revenue growth for large-caps. That said, we anticipate considerable cross-currency headwinds (50–60bps) for the top-five Indian IT players—courtesy a very strong USD (up 4.2%/0.9% versus GBP/EUR for Q2FY20). In the mid-cap space, revenue growth will remain a challenge in the forthcoming quarter owing to client-specific issues. We will watch out for management commentaries pertaining to demand outlook in North America while any signs of recovery in European BFSI clientele will be welcome.
Green shoots of margin recovery on the cards
After enduring a difficult Q1FY20 marked by wage hikes, visa costs and a strong INR, all of which dragged margins, we anticipate a healthy recovery in margins across the board in Q2FY20. Except TechM, whose margins may remain under pressure owing to upfront costs incurred on ramping up its new deals, we expect other large-caps’ margins to expand by 50–90bps QoQ. Meanwhile, mid-caps too should embark on their journeys to margin recovery.
Outlook: Demand intact; prefer Model Portfolio
We remain positive on the IT sector at large, wallowing in strong demand fundamentals. As digital service offerings such as cloud move from the pilot stage to implementation across enterprises, deal sizes in digital are increasing, benefitting large caps. Meanwhile mid-caps, wherein both revenue growth and healthy margins have been hard to come by over the past couple of quarters, should begin to see margin recovery, thereby leading to earnings growth. We maintain ‘BUY’ on Infosys, TECHM and HCLT, and ‘HOLD’ on TCS and Wipro. In mid-caps, we prefer L&T Infotech and Mindtree, maintaining ‘BUY’ on both.