There was lack of consistency in any segment on growth, with one or two players doing well and the other two doing materially worse, suggesting individual client exposures and market share gains were the drivers of demand.
We retain view of no material accelaration in FY19F and margin pressures. Key indicators: (i) tier-1 IT (ex-CTSH) revenue growth stayed soft at 6.8% y-o-y in constant currency (CC), with 3 of 4 companies missing growth/margin estimates, suggesting no material acceleration in FY19F; (ii) lack of consistency in demand, with 1 or 2 players performing in any segment and the others materially underperforming; (iii) momentum was slow in US among geographies, BFSI/manufacturing/ healthcare among verticals and ADM/ES among services. Telecom decelerated and IMS/BPO did not grow materially faster; and (iv) margins were flat q-o-q with outlooks moderating with traditional levers exhausting. We estimate USD revenue and PAT CAGRs of 7/5% over FY18-20F for tier-1 IT (ex-CTSH) and remain below consensus ex-HCLT on growth/EPS.
Large segments weak – US, BFSI/Mfg, ADM/ES and legacy
Key negatives: (i) US revenue growth (ex-HCLT) was at 4% y-o-y; (ii) BFSI/Mfg /Healthcare/Telecom at 5-6% y-o-y in CC were weak; (iii) ADM/ES (2/5% y-o-y in CC) and past performers IMS/BPO did not grow materially faster; and (iv) legacy (non-Digital ~75% of rev) showed 4-5% y-o-y decline in CC at TCS/WPRO.
Energy/Europe strong, Retail improves, Digital strength
Key positives: (i) Energy and Europe grew at 10% or higher; (ii) Retail, after slowing to zero growth, improved to 7% y-o-y in CC; (iii) Digital was strong at 29/43% y-o-y for WPRO/TCS in CC terms; and (iv)Engineering services continued to be the fastest growing segment up 20% y-o-y, partly aided by inorganic contribution from HCLT.
Ebitda growth flattish; CFO growth also turns tepid over LTM
Other highlights: (i) Ebitda growth (ex HCLT) at 0-2% y-o-y in FY18 and CFO growth (ex TCS) tepid at 3% to -9% y-o-y ; (ii) 3-year FCF CAGR at 2/-2% for INFO/WPRO and receivables-led better performance at TCS might not be sustainable; and (iii) utilisations near 3-year peak, headcount addition muted at 1.8% y-o-y and quarterly annualised attrition rose at all players ex TCS on y-o-y basis.
Valuations at ~15% premium to historical average; stocks re-rate
Tier 1 IT has re-rated sharply despite consensus FY19 EPS estimate cuts. Since Apr-16, estimates for HCLT have been cut 4%, but the stock is up 23%; TCS: 13% EPS estimate cut, stock up 38%; INFO: 17% EPS estimate cut, stock up 1%; and WPRO: 18% EPS estimate cut, stock down 10%. Tier 1 IT valuation at 19.5x one-year fwd EPS, at ~15% premium to historical average.
HCLT and CTSH preferred; INFO/TCS top Reduce ideas
The sector continues to face structural issues (higher exposure to slower-growing legacy), competitive pressures (MNCs, challengers and insourcing), margin pressures (INR appreciation/pricing led) and external risks. Structural factors to outweigh cyclical improvements and valuations already build a material recovery. Hence, we remain cautious. Pecking order: HCLT > CTSH > TECHM (Neutral) > WPRO > INFO > TCS (Reduce).
Q4 does not offer a reason to build material turnaround into FY19F
We have been cautious on the sector’s growth and margins prospects for almost three years now, and fiscal Q4 results do not suggest any turnaround on growth, even though stocks have lately re-rated sharply on hopes of a growth rebound in FY19F, sector rotation in light of material fund flow for domestic institutional investors and fears of INR depreciation. There was lack of consistency in any segment on growth, with one or two players doing well and the other two doing materially worse, suggesting individual client exposures and market share gains were the drivers of demand. The only segments where there was some semblance of consistency was Europe among geographies and Engineering services within sectors.