IT companies like TCS, Wipro, HCL Tech to see weak third quarter on Chennai floods

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Updated: January 11, 2016 11:44:50 AM

More important than the third quarter performance will be commentary on 2016 IT budgets and FY17 growth outlook based on contract signings (TCV) in the third quarter.

computer-software-L660IT sector review: The third quarter is likely to be a weak quarter impacted by the double whammy of lower working days/furloughs and Chennai floods.

It’s well acknowledged by the street that the third quarter is likely to be a weak quarter impacted by the double whammy of lower working days/furloughs and Chennai floods. We expect nearly flat growth sequentially (+/- 1% on reported basis) and 50-120bps margin impact across most companies. In constant currency (excluding one-offs and Chennai flood impact) growth should be 1-3% q-o-q (quarter on quarter). However, more important than the third quarter performance will be commentary on 2016 IT budgets and FY17 growth outlook based on contract signings (TCV) in the third quarter. Infosys’s & Wipro’s commentary/guidance for Q4FY16 will be critical as well.

Indian IT Services 2016 outlook: We expect 2016e’s industry growth to be just about in line with 2015’s in constant currency terms. However, stocks are likely to do better after the valuation de-rating and downward earnings revisions in 2015. Key themes likely to drive demand and stocks in 2016e or FY17e include: (i) demand upside from digital; (ii) impact of growing multi-dimensional competition; (iii) macro-economic outlook and its
impact on BFSI spending; and (iv) continued impact of growing unfavourable base.

Digital– new or renew: We think digital will continue to dominate incremental IT spending globally. However, in our view, digital technologies are just an evolution of traditional areas of IT spending and thus are unlikely to materially change the overall trajectory of IT spending and consequently the Indian IT sector’s growth. Without digital spending, global IT spending could have been flat to negative currently.

Growing competition: Further, while Indian companies continue to gain market share globally, the pace of market share gains is likely to be impacted by the growing prominence of majors (eg, Accenture [ACN; CMP USD102, not covered]) and niche players (eg, EPAM [EPAM; CMP USD 76], Luxoft [LXFT US; USD 72], Globant [GLOB; USD 37 all not covered]) and GICs (captives) in India. This is likely to restrict positive surprise on growth.

Unfavourable base: Even though consensus expectations have come down recently, the top-five outsourcing companies still need c.$6.5 bn of incremental revenues in FY17/18e to achieve 11-12% revenue growth, which would not be easy to beat.

Macroeconomic acceleration is the upside to our forecasts. A rising tide lifts all boats. The banking industry (BFSI) appears to have stabilised and an anticipated pick-up in earnings growth in 2016/17e may lead to higher spending which may lead to our current estimates being beaten. Admittedly it’s a macro call and at this stage only a hope.

Infosys

We expect USD revenues to decline 1.3% q-o-q. We factor in net impact of 40-50bps due to Chennai floods and a negative cross currency impact of c40bps on the top line. Constant currency (cc) organic revenues are expected to decline 0.5% q-o-q. Absence of one time revenue (c1%) booked in second quarter and weakness in
insurance, energy and telecom should impact growth in a seasonally weak quarter.
* Margins are estimated to decline 80bps sequentially on account of revenue decline, investments in large deals and costs  associated with Chennai flood impact. INR depreciation (+50bps) and operational efficiencies should offset some of the headwinds.
* Key focus: Commentary on customer budgets for 2016; update on deal wins/deal ramp up in the quarter and commentary on IT spending trends by vertical.

TCS
* We estimate revenues to grow 1.5% q-o-q in constant currency (ex one-offs) which should be completely
offset by negative cross-currency movement and impact of Chennai flood. TCS has the largest presence
in Chennai.
* Ebit (earnings before interest and taxes) margins are likely to decline c100bps q-o-q in the quarter marginally offset by INR depreciation.
* Key focus: Outlook on overall business environment by region and update on client budgets.

Wipro
* We expect revenue growth of c1.5% q-o-q in constant currency (ex one-offs) in the IT services division. Cross-currency should impact USD revenues by c70bps in the quarter and floods should have a net impact of 40bps on top-line.
* Margins in the IT services business are likely to be down 70bps on account of the revenue impact in the quarter, offset by INR depreciation.
* Key focus: Strategic roadmap by the recently appointed CEO (Abid Ali Neemuchwala) and updates
on any likely restructuring. The Q4 growth guidance, and updates on demand outlook will be in focus as well.

HCL Technologies

HCLT is likely to be the most impacted (by c 100bps) due to the floods in Chennai owing to c40% of workforce in the city. We expect quarter revenue growth in cc (ex one-offs) to be 2.5% q-o-q.
* The quarter will have an impact of 75bps from a partial wage hike and nearly 100bps impact from impact of floods.

This should be partially offset by INR depreciation and operational efficiencies. We expect overall margins to decline 120bps q-o-q to 19.2% as compared to the normalised 20.5% margin in Q1FY16
* Key focus: Commentary on growth expectation for second half of FY16, update on demand environment and deal wins will be key.

Tech Mahindra
* We expect revenue growth of 2% q-o-q in constant currency. Ramp up in recent deal wins and acquisitions should help maintain growth despite weakness in Telecom vertical and furloughs. TechM is likely to be least impacted among the top 5 due to the Chennai floods (c20bps).
* Margins are likely to expand 100bps q-o-q on account of SG&A leverage, INR depreciation and improving margin profile for the LCC business. Impact of Chennai flood may only marginally offset margins.
* Key focus: Commentary on the Telecom vertical, large deal wins and operational performance of recent acquisitions.

Mindtree
* Mindtree is expected to grow 1.5% q-o-q in constant currency (ex one-offs). Impact of floods and cross currency should collectively impact top-line by 70bps.
* Margins may decline 60bps due to partial impact from wage hike and headwinds to USD growth.
* Key focus: Incremental new deal wins in the quarter and details on the overall business environment.

Gr1

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