TCS, Infosys, Wipro, Q4 preview: Overhang of seasonality likely; HCL Tech is top pick

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Published: April 11, 2017 3:52:14 AM

Company managements’ comments on FY18 could be one near-term trigger for stocks; HCL remains the top pick

Indian IT companies have been sounding optimistic on the potential cyclical recovery in IT spending, particularly in US BFSI.

The fourth quarter is typically better than the Q3 but softer than Q1/Q2. This seasonality, together with company-specific factors, may lead to a soft Q4. We expect the larger Indian IT firms to report -0.4-2.3% q-o-q revenue growth in constant currency and organic terms (Wipro at the lower end and TCS at the upper end). Margins should be largely stable q-o-q. Cross-currency impact may range from -40 bp to +70 bp, and with 0.7% ` appreciation against the $, currency should be a net negative for ` revenue and margins.

FY18 outlook and guidance will be important: Indian IT companies have been sounding optimistic on the potential cyclical recovery in IT spending, particularly in US BFSI. This same optimism was echoed by Accenture and Cognizant managements. However, this has not translated into any near-term expectation of revenue acceleration. Cognizant has guided for 2017 growth similar to 2016 growth and Accenture’s guidance implies a deceleration from FY16. Company managements’ comments on FY18 could be one near-term trigger for the stocks. We expect Infosys and HCLT to guide to revenue growth of 7-9% and 9-11%.

HCLT remains our top pick: Despite relative outperformance over the past three months, we believe HCLT is better positioned with low downside risk—valuations are reasonable, business momentum seems fine and the immigration impact (if any) would be relatively low. Any improvement in cyclical factors should benefit them as well. We see a lot of value in the TechM stock but near-term telecom momentum seems weak again for them. We slightly tweaked earnings estimates to account for currency movements. For TechM, we cut earnings estimates by 6-9% and TP by 4.5% to reflect the ramp down in network services business, and associated margin impact.

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Mar-17: FY18 outlook will be key

TCS is likely to end with 8.5% revenue growth in FY17, the lowest in the past six years. While management’s commentary was reasonably optimistic post the Q3 result, there have not been many data points to suggest a near term acceleration in revenue growth. After a soft start to the year , TCS witnessed some recovery in Q3. Communication and media segments were weak in Q3, but management termed it quarter-specific. It also indicated a “sense of buoyancy” in customer sentiment. We believe the visibility of any recovery remains low at the moment, and also the margins may settle at close to the lower end of management’s guided range of 26-28%.

Management in Q2 results indicated better sequential growth in H2 FY17, and there was nothing negative in its commentary for Q4 FY17. We expect decent 2.25% q-o-q revenue growth in Q4 FY17 in constant currency. The currency may have a net negative impact on margins, which may be offset by efficiency gains; we expect margins to remain broadly flat q-o-q.

Infosys had a soft Q3, impacted by over 1% due to an RBS contract ramp down, and also had broad-based weakness across the top clients. It narrowed the FY17 revenue growth guidance from 8-9% to 8.4-8.8%, implying 0.3-1.8% growth in Q4 FY17. Similar to TCS, Infosys remains hopeful of a recovery in the US business. While management does not view the broad-based weakness in top accounts as a trend, similar weakness in Q4 FY17 as well would be a concern. Infosys has slightly underperformed TCS in the past three months.

We expect Infosys to report 1.3% q-o-q revenue growth in constant-currency terms, in the upper half of its implied Q4 guidance of 0.3-1.8% growth. Cross-currency impact is likely to be neutral. Margins may largely remain unchanged.

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