Margins should not be hit as hard as feared; deal signings key metric; Infosys, TCS and HCLT are top tier-1 picks.
Accenture’s recent result and commentary have set a baseline expectation for Indian IT companies. However, as we highlighted earlier, the Healthcare vertical of Indian IT is not as big as that of Accenture (18% of sales). Accordingly, it may not move the needle to that extent in the case of Indian IT. Nevertheless, we believe Indian IT should demonstrate a similar operational resilience.
As the quarter progressed, supply-side issues eased as most countries re-opened their economies. Barring a few areas, such as ER&D, the supply side should not see further material bottlenecks. However, demand issues persist and are more pronounced in some verticals (e.g., Retail, Travel, Transportation and Hospitality, and Aerospace).
For Q1FY20, we expect aggregate revenue (USD)/revenue (INR)/ Ebit/PAT to grow by -4%/5%/5%/0% y-o-y, respectively. On a sequential basis, Tier I revenue should move in the range of (8.0)%–(4.5)% (CC) and (8.5)%–(4.8)% (USD), with INFY/TechM leading/lagging behind the pack. Across Tier II, revenue should move in the range of (15)%–(3)% (q-o-q, CC) and (15)%–(5)% (q-o-q USD), with LTI/Cyient leading/lagging behind.
Margin disruption should not be as severe as feared
Our recent interactions with companies suggest that pricing pressure was not to the extent anticipated earlier. While a fall in utilisation levels and negative operating leverage should hurt margins, they should be partly offset by sharp INR depreciation, the deferral of salary revisions, and the absence of certain G&A/PM CARES fund related expenses. Overall, while the sequential Ebit margins of Tier I should contract by (240)–(70)bp, our Tier II coverage should move in range of (180)–50bp.
For the full year, we currently build in a (310)-320bp Ebit margin impact for our coverage universe. However, subject to companies’ commentary, there may be an upside risk to our estimates.
Deal wins data a key observable
Limited visibility on recovery, coupled with the risk of a potential second wave, should render it challenging for companies to provide guidance even this time. Deal signings in Q1FY21 and commentary around the pipeline are likely to be the key focus areas for investors as this is the latest available proxy for demand. Moreover, as this would be the first full quarter where the majority of associates would be working from home, operational metrics in the new normal would also be keenly watched.
Compelling long-term outlook
Despite near-term uncertainties due to COVID-19 and the US elections, we continue to like Infosys/TCS/HCLT among Tier I and LTI/Mindtree among Tier II. This is attributable to their robust business models, high return ratios, strong management teams, and reasonable valuations. These companies have had a legacy of overcoming multiple business challenges and technology change cycles in the past. Accordingly, we believe they would be able to adapt and overcome any transient challenges posed by COVID-19.