With the fiscal third quarter earnings season all set to commence this week, brokerage firms said that the Indian IT services sector is expected to post a mixed performance during the seasonally weak quarter. Q3 is traditionally considered weak due to seasonal furloughs which, per analysts, is expected to weigh down the IT sector’s growth. JM Financial said, “Q3FY25 will be indented by furloughs. Its impact will likely be similar to last years’. That is hardly encouraging given furloughs were deeper (more clients) and longer last time around. We expect a muted (0.5)-1.4 per cent cc QoQ growth for large-caps (ex-HCL). HCL’s growth should however be stronger (5.5 per cent cc QoQ) on specific factors (software sales, in-organic). We expect 10-50 bps QoQ margin expansion across the top-5.”
Motilal Oswal Financial Services (MOFSL) said, “After a decent Q2, we expect seasonal furloughs to weigh on growth for the sector in Q3FY25. That said, looking beyond seasonality, macro uncertainty is gradually easing and we expect the outlook for technology spending to improve in CY25. While the initial phase of recovery in H1FY25 was sluggish, we now see clear signs of an acceleration. Recovery appears to be expanding beyond US BFSI—which continues to strengthen—into additional industry verticals such as Hi-Tech, which is recovering ahead of schedule.” It further added that the most important catalyst for the sector now would come after Q3FY25, when client budgets for CY25 would be finalized and the magnitude of change in client behavior would become clearer.
Tier-2 companies to outpace tier-1 firms
According to analysis by brokerage firms, Tier 1 IT companies like TCS, Infosys, and HCL Tech are expected to post modest growth in Q3 and tier 2 firms such as Coforge are likely to show stronger sequential revenue growth, driven by effective operational execution. JM Financial stated that Persistent Systems and Coforge among mid-caps are expected to outpace larger peers again.
Elara Capital also maintained that HCL Tech, Coforge and Persistent Systems are expected to report strong sequential dollar revenue growth in Q3FY25. Revenue growth for Coforge and Persistent Systems may be supported by strong orderbook and for HCL Tech, by its seasonally strong Products & Platform (P&P) business. “Dollar-denominated revenue growth for Tata Consultancy Services, Infosys, Wipro and Tech Mahindra should sequentially drop due to furlough impact and unfavorable currency movements. Furlough impact in Q3 is expected to be normal this year.”
MOFSL analysis added, “Among Tier-I players, we prefer LTIMindtree as we believe its vertical exposures in BFSI and Hi-tech, as well as its service line exposures in data, ERP and modernization, position it well for a recovery in client spends in FY26/FY27. Among Tier-II players, our top pick is Coforge. Coforge’s strong offerings in BFS and insurance should enable it to participate in the demand recovery, and a strong TCV also indicates a robust near-term growth outlook.”
Q3 revenue growth estimates
According to an analysis report by MOFSL, Tier-I IT companies are expected to report revenue growth in the range of -1.0 per cent to +3.7 per cent QoQ CC. Revenue of Tier-II players, meanwhile, is expected to grow to the tune of 0 per cent to ~5 per cent QoQ in CC terms. “We expect QoQ constant currency revenue growth of ~0.4%/ 1.0%/ 3.7% for TCS/Infosys/HCL Tech. Mid-tier companies should continue to do well; we expect Coforge/Persistent Systems to grow by 4.9%/4.0%, whereas Mphasis/Cyient could show 0.2%/2.3% growth.”
Elara Capital, meanwhile, said that in terms of revenue growth, HCL Tech, Persistent Systems and Coforge are expected to lead. “We expect HCL Tech to report a sequential growth of 3.3 per cent in USD terms, led by its P&P business. Expect a 20 per cent QoQ growth in P&P due to seasonality. IT services and ER&D business may grow by 1.5 per cent and 1.8 per cent QoQ, respectively. For Persistent Systems, we expect a 3 per cent QoQ USD revenue growth in Q3E, driven by strong orderbook,” it added while maintaining that growth in Q3 should be led by Hi-Tech and HLS verticals and normal furloughs may play out for the BFSI vertical due to which growth may seem optically lower than in Q1/Q2.
Q3 margins projection
Margins, according to brokerage firms, are likely to be stable outside of wage impact. JM Financial said, “We expect margins to be stable outside of wage impact as INR depreciation benefit is partially eroded by adverse cross-currency. HCL Tech, LTIMindtree and Tata Technologies will see full quarter impact of wage hikes while Coforge/Persistent Systems will benefit from its absence (rolled-out in Q2). We estimate 10-50bps margin expansion among the top 5.”
Infosys’ project Maximus and Tech Mahindra’s project Forteus (margin programs) should continue to yield benefits, though a weak top-line might weigh on headline margins. Per analysts at JM Financial, HCL Tech’s margin expansion (+50bps QoQ) will likely be lower than that of previous Q3s due to unfavourable comp (Q2 margin was elevated due to higher Software sales). LTIMindtree could see 220bps QoQ decline weighed by 300 bps impact of wage hike. Coforge’s adjusted EBITDA margin could expand by 130bps. Higher ESOP expenses would however keep the reported margin flattish.
Key monitorables
The investors and market participants are hoping for a better IT budget for CY25 as uncertainty around the US Presidential election and Fed rate cut is behind. However, JM Financial said that there are not much expectations on clarity to emerge as clients might wait for Trump to take office on Jan 20, before firming up their plans. “Any spill over of furloughs (like FY24) into Q4 could be concerning. Pick-up in deal TCV, though unlikely, will be important as FY24’s mega deals’ contribution comes into the base. Durability of smaller deals could be a precursor to discretionary spend revival,” the brokerage firm said.