HCL is likely to lead on q-q CC growth, followed by Infosys; some tempering of outlook expected for H2FY20
Tier-1 IT (ex CTSH) is likely to post aggregate growth of ~3.2% q-o-q in CC (vs 2.3% in Q1FY20 and 3.5% in Q2FY19) and 10.9% y-o-y. We see negative CC impact of 75-90bp on Tier-1 IT (ex CTSH) and 30-50bp impact on mid-cap IT in Q2 led by depreciation of GBP/EUR/AUD. INR depreciated 1.3% q-o-q on average, which could benefit Ebit margins to the tune of ~20-30bp. We expect HCLT to lead with 6.2% q-o-q CC growth, by contribution from IBM IP (though we expect organic growth to be weak at ~0.5% q-o-q CC), followed by INFO at 3.4% q-o-q CC growth (~0.7% contribution from Stater) led by strong deal win momentum, and TCS at 2.6% q-o-q CC growth (y-o-y growth at 9.4% CC is below double-digits). We think growth is likely to be muted at TechM at 2.2% q-o-q CC owing to weakness in Enterprise and WPRO at 1.2% q-o-q in CC (vs guidance of 0-2%) given weaker commentary across verticals.
On guidance, we expect companies to retain revenue and margin guidance for FY20F; though we see likelihood of upsides at HCLT and INFO in 2HF. We see risks to double-digit growth guidance at TCS and expect WPRO to guide for 0-2% growth in Q3. While 1H growth has been supported by strong deal wins, we expect some tempering of the outlook for 2HF on weaker macro and weakness in BFSI. Our top pick in the sector is HCLT.
Margin pressures continue
Ebit margins at Tier-1 IT may see 90-150bp q-o-q improvement, led by tailwind from visa/ wage, operational improvements at INFO and high margin IBM IP business at HCLT. Ebit margins at WPRO will likely be impacted due to a 2-month wage hike and weak revenue momentum. We expect HCLT/INFO to retain margin guidance of 18.5-19.5%/21-23% respectively for FY20F, and expect some tapering at TechM due to the AT&T deal and forecast Ebit margins below 26-28% aspiration at TCS. Key risks to margins remain: (i) rising onsite costs including sub-contractors given immigration risks and supply-side issues in the US; (ii) pricing pressure in legacy and investments in Digital; and (iii) high attrition and limited operating levers especially at TCS/WPRO. We expect Tier-1 IT (ex CTSH) Ebit margins to fall from 22.7% in FY19 to ~21.6% by FY21F.
Key to monitor: Our takeaways on BFSI, Europe and deal wins
BFSI: Weakness in tech budgets with focus on repurposing spends to new, along with weak client financials will impact Tier-1 IT growth in BFSI in FY20. Softness is visible from comments at Tier-1 IT & ACN and capital markets and large EU banks are key areas of weakness.
EU: We see risks in EU (fastest growing geo for Tier-1 IT at 12% y-o-y), given softer macro, weakness in EU BFS and Auto and tepid commentary from ACN (grew ~4% y-o-y). TCS, however, continues to indicate positive momentum in Europe.
Deal wins: Strong deal wins in FY18-19 spurred growth for Tier-1 IT over past couple of quarters and is likely to be monitored given weakness in macro and BFSI/Mfg.