We estimate the top 5 Indian IT players—Infosys, TECHM, HCLT, TCS and Wipro—to report revenue growth of 1.6–4.1% QoQ in constant currency (cc) in Q3FY20. A strengthening GBP versus USD is likely to add 20–35bps to cc growth, in our view. Barring TechM and HCLT, we expect margins of the other three to rise 40–65bps QoQ as weak INR (down 1% QoQ vs USD) and operational levers kick in. Though furloughs could impact revenue growth of mid caps, QoQ margin recovery is likely to continue for most players led by headcount rationalisation. Sustained momentum in digital and robust deal pipeline across verticals are likely to underpin strong management commentaries. We will keep an eye on:
i) increase in deal sizes & tenures in digital;
ii) demand commentary, specifically BFSI & retail; and
iii) commentary on the improving geopolitical scenario.
Maintain ‘BUY’ on Infosys, TECHM & HCLT and ‘HOLD’ on TCS & Wipro.
Cross currency tailwinds to help growth in seasonally weak quarter
We expect most large caps to report 1.5-2.5% revenue growth in cc, except TechM (4.1% QoQ, cc), which should see growth skewed towards H2FY20. That said, we also anticipate cross-currency tailwinds (20-35bps) for the top-five Indian IT players, courtesy a strong GBP (up 4.0% versus USD in Q3FY20). In the mid-cap space, revenue growth is likely to remain a challenge in the forthcoming quarter owing to impact of furloughs. We will watch out for management commentaries pertaining to demand outlook in North America, specifically in BFSI and retail, while outlook on hi-tech, communication and telecom will also be crucial.
Furloughs to partially hinder margin recovery
While major margin headwinds such as wage hikes and visa costs are behind, we believe margin recovery, while aided by a weak INR could be partially offset by impact of furloughs. We estimate TechM’s margin to contract 60bps as upfront costs incurred in ramping up new deals could compress margin. Meanwhile, mid caps too are likely to continue on the road to margin recovery.
Outlook: Demand intact; prefer Model Portfolio
We remain positive on the IT sector at large, citing continually strong demand fundamentals. As digital service offerings reach implementation stage across enterprises, deal sizes and tenures in digital are increasing, benefitting large caps. Meanwhile mid caps, after seeing plummeting growth and margins, have started recovering their margins led by better utilisation and headcount rationalisation. In order to better navigate this phase, we recommend the Model Portfolio detailed in our latest report. We maintain ‘BUY’ on Infosys, TECHM & HCLT and ‘HOLD’ on TCS & Wipro.