Technology: Could BFSI wane seasonal strength

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Published: October 8, 2019 1:32:21 AM

Although July-September is the strongest quarter for the industry, softening BFS momentum (owing to macro concerns in Europe and weak spending by capital market clients across geographies) is a cause for concern.

TCS and INFO are likely to deliver sequential margin expansion off a low base, while HCLT is likely to benefit from the integration of the high-margin IP business (Image source: Express Computer)

We expect our coverage universe to deliver sales/EBIT/PAT growth of 8.7%/2.5%/-1.8% y-o-y in Q2FY20. Although July-September is the strongest quarter for the industry, softening BFS momentum (owing to macro concerns in Europe and weak spending by capital market clients across geographies) is a cause for concern.

Sequential organic constant currency (CC) growth across our Tier-1 universe is estimated at 0-2.5%, with TCS, and INFO likely to grow at the higher end of the range. Overall CC growth at INFO and HCLT will better that range, led by inorganic contribution. TCS and INFO are likely to deliver sequential margin expansion off a low base, while HCLT is likely to benefit from the integration of the high-margin IP business. WPRO’s margin performance is expected to be the softest across Tier-1 with an impact from two months of wage hikes.

However, we note that increasing supply crunch, higher visa/sub-contracting expense and elevated investments in digital have been driving a structural contraction in margins. EBIT margin for Tier-1 companies is estimated to shrink 120bp y-o-y but expand 80bp q-o-q due to a low base (impacted by seasonal expenses).

While growth across midcaps is expected to be relatively good compared to Tier-1 (aggregate 8.2% y-o-y in US dollar terms for Tier-1 v/s 10% for Tier-2), LTI’s performance (1% q-o-q CC) might lag given some client-specific challenges. Particularly, the revenue performance at MPHL, MTCL, NITEC and HEXW is likely to be strong, with the latter two getting a boost from the integration of inorganic transactions in the quarter.

In terms of margins, wage hikes at LTI, PSYS and ZENT are likely to drag the performance. While a sharp recovery on the low Q1 base is crucial for MTCL and CYL, we do not see that happening due to limited levers for the former and revenue pressures for the latter. Overall, as cited in the past, the supply situation will hurt Tier-2 more than Tier-1, and we expect a continuum of this trend.

Aggregate EBIT margin for Q2FY20 is estimated at 21% for Tier-1 and 13.5% for Tier-2. On a y-o-y basis, the differential between the margins of Tier-1 and Tier-2 is estimated to have increased by 70bp, indicating cost pressure on Tier-2 companies amid supply crunch and digital investments.

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