Q4FY16e preview—soft but steady: Seasonal weakness will reflect in modest 1.5-2.5% sequential constant-currency (c/c) revenue growth of Tier-1 ITs. Margins will improve for most companies after Chennai flood-led decline in the December quarter; about 2% depreciation in the rupee will also help. We expect March quarter results and management commentary to lend comfort on FY2017 moderated estimates. Portfolio of clients and the ability to participate in digital will significantly influence growth of IT companies in FY2017, in our view. We back Infosys, our top pick in the sector.
Tier-1 IT’s c/c growth to be in a narrow band of 1.5-2.5%: We expect 1.5-2.5% c/c revenue growth for Tier-1 IT in the March quarter. Cross-currency impact will be 20-50 bps largely led by ~5.5% depreciation in GBP against $. Rupee depreciated ~2% while yen appreciated ~5% against $. Most other relevant currencies have remained stable. We expect c/c sequential growth of Tier-1 IT to be in narrow band—HCLT (2.5%), Infosys (2.2%), TCS (2%) and Wipro (1.5% organic; 3% reported c/c). We note that the March quarter is a seasonally strong quarter for Wipro while Infosys has worked to overcome its traditional seasonal weakness. Tech Mahindra will report a weak quarter with broadly flat c/c growth as seasonal weakness and challenges in network services (LCC) outweigh seasonal strength of the VAS business (Comviva). We expect 1% organic c/c growth (4% reported c/c) for Mindtree and 2.2% c/c growth for Hexaware.
Expect margins to improve after a fall in December quarter: Ebit margins of Tier-1 Indian IT declined 50-60 bps in the December quarter largely led by lower billing days and one-time costs pertaining to floods in Chennai. Additionally, about 1-2% q-o-q improvement in realised rupee/$ rates on the back of 2.2% rupee depreciation will help margins by 25-50 bps. We expect 45-65 bps improvement in Ebit margin for Tier-1 IT except Infosys (write-backs of provisions aided margins in the previous quarter). Tech Mahindra will broadly maintain margin despite headwinds from annual wage increments. We note that Ebit margins will be down by 20-130 bps y-o-y.
Infosys to guide relatively
robust 11-13% growth in c/c: Healthy order book, robust deal pipeline and improving deal win rates augur well for Infosys. Broader market challenges in the banking vertical may result in some pushback of IT spend and longer decision cycles, although market share gains will neutralise some of the challenges for Infosys. Key changes, under the leadership of Dr Sikka, to the approach and response to RFPs, emphasis on innovation and scrutiny of the CEO and COO of large deals, have improved the success ratio in large deal wins and account mining. The benefits of these changes will continue. We expect Infosys to guide 11-13% c/c revenue growth in FY2017.
Automation and digital likely to be key discussion themes: We expect investors’ focus and earnings call discussions to revolve around two key themes—(i) Digital: We expect companies to detail capabilities spanning sub-segments of digital (skills, ecosystem partnerships, solutions and IPs created, etc.), deal wins and projects executed. Among Tier-1 Indian IT, TCS has taken the lead by disclosing digital revenues and showcasing a number of live/completed projects. (ii) Automation: Progress on automation is important as it determines the ability to offset the pressure on pricing in traditional businesses. Besides, we expect managements to offer more colour on demand outlook for FY2017—budget closures, price negotiations and decision cycles.
Maintain positive stance, Infosys remains our top pick
We expect a slightly soft but steady 10-11% growth for Indian IT in FY2017. We expect March quarter results and management commentary to lend comfort on Street’s expectations, which in our view are already moderated, realistic and achievable. We believe 1-2% lower growth in FY2017e is captured in the new valuation band—Indian IT stocks are down to 14-18X from 15-20X. The new valuation band implies that stocks are building 10-13% growth as against 11-15% earlier, for a period of 4-7 years. We note that there is potential for growth to pick up from current levels as Indian IT’s participation in digital increases. Infosys is our top pick among large caps. We like Tech Mahindra (TM) for its continued strengthening of leadership in telecom and progress on the enterprise segment even as we caution that the near-term outlook is weak.
l Infosys: We estimate sequential revenue growth of 2.2% in c/c and 1.9% in $ terms. Growth will be led by BFSI and retail verticals and the US. Ebit margin will decline by 30 bps due to (i) absence of write-back of provisions that aided margins in the December quarter and (ii) pricing pressure in new projects although it would be offset by gains from rupee depreciation. We expect solid progress in client metrics, robust TCVs and acceleration of growth in IMS. We expect FY2017e guidance of 11-13% c/c revenue growth with 24-26% Ebit margin band.
Investors would keenly track management commentary on (i) demand environment in key verticals, particularly BFSI (ii) pricing outlook, growth versus margin trade-offs and progress on automation and (iii) Infosys’ positioning in the digital landscape. We have an ADD rating on the stock with a target price of R1,300.
l TCS: We expect TCS to report 2% growth in c/c and cross-currency impact of 50 bps. Cross-currency headwind from 14-15% exposure to GBP (depreciated ~5.5% versus $) will be partly offset by about 4% exposure to Japanese yen (appreciated ~5% versus $). TCS’ Ebit margin in the December quarter was impacted by floods in Chennai. We expect margins to improve by 45 bps q-o-q partly aided by rupee depreciation. Focus will be on TCS commentary on demand, growth outlook and its positioning in digital. We have an ADD rating on the stock.
l Wipro: We estimate c/c revenue growth of 3% (1.5% organic) around midpoint of its c/c growth guidance of 2-4% (organic c/c growth guidance of 0.5-2.5%). We expect 50 bps improvement in Ebit margin led by absence of costs pertaining to Chennai floods, benefits of rupee depreciation and some recovery in profitability of the IT products segment. We expect Wipro to guide 3.5-5.5% c/c revenue growth (1-3% organic c/c growth) for Q1FY17. We note that full quarter consolidation of cellent, Viteos and HPS acquisitions will aid revenues by about 2.5% in Q1. Street focus will be on (i) the new CEO’s priorities and progress on that front (ii) efficacy of measures taken to improve sales effectiveness, account mining and to defend shares in core areas of competence (iii) go-to-market strategy of digital business (iv) wins in consolidation deals in energy and BFSI verticals and (v) integration of recent acquisitions of Viteos, cellent AG and HPS. We have a REDUCE rating on Wipro with a target price of R550.
l HCLT: We expect HCLT to report 2.5% growth in c/c and 2% growth. Growth would be driven by IMS and engineering services. HCLT’s Ebit margin in the December quarter was impacted by 60 bps due to one-time cost associated with Chennai floods and investments in tools, software and assets. We expect Ebit margin to improve by 65 bps. Investor focus would be on (i) FY2017 demand outlook (HCL Tech to shift to March-ending fiscal year from June) (ii) growth prospects and investments in service lines other than IMS and ERD (iii) focus areas in digital and how the company intends to catch up with competition and (iv) profitability trends after the disappointment in FY2016. We have a REDUCE rating with TP of R850.
l Tech Mahindra: We expect Tech Mahindra to report c/c revenue growth of 0.3% and a decline of 0.3% in $ revenues. Growth will be led by the enterprise business. Telecom vertical revenues would decline sequentially as seasonal strength in VAS business (Comviva) will be more than offset by weakness in network services (LCC). We expect Tech Mahindra to be able to restrict Ebit margin to 10 bps despite annual wage increments led by operational efficiencies, rupee depreciation and higher revenues from Comviva (seasonal) that flows through to Ebitda. We expect investors to focus on (i) deal pipeline in telecom (ii) turnaround strategy for LCC (iii) roadmap for further improvement in margins (iv) growth outlook for top accounts in telecom vertical and (v) effectiveness of initiatives to improve productivity and drive automation. We have a BUY rating on the stock with a target price of R600.