Weak start to the year but optimism prevails for H2 in Indian IT sector: IIFL Sector

9 Jun 2023 , 11:49 AM

Analysts of IIFL Capital Services met with several Indian IT companies across the market cap spectrum this week to gauge the demand environment with the backdrop of EPAM’s guidance cut spooking the markets. Key takeaways from their meetings are: (1) demand environment hasn’t materially deteriorated though it is not indicating stabilization as well, (2) analysts of IIFL Capital Services are potentially heading for a softer than usual revenue growth in Q1FY24 as ramp downs from Q4FY23 spill over, (3) deal awards and pipeline have remained healthy though customers are reluctant to ramp up some of these contracts immediately, (4) deferment, and not cancellation, of deal ramp ups is giving the companies comfort that H2FY24 could see better than usual growth, (5) easing supply side should result in lower wage hikes this year, cushioning the Ebit margins, though tailwinds may get diluted by lower operating leverage due to weaker growth this year. Analysts of IIFL Capital Services believe sector valuations have little room for upside as despite a deteriorated growth outlook, Nifty IT Index has performed in line with broader markets YTD. They continue to like stocks with relatively attractive growth adjusted valuations such as INFO, TCS in large caps and PSYS, COFO among mid-caps and recommend avoiding value plays.

Infosys – All eyes on large deals: 

INFO reiterated that higher proportion of discretionary revenues led to higher decline in their revenues in Q4 relative to other large cap peers. Without giving a midquarter update as such, INFO suggested macro uncertainty could continue to impact near term growth and customers’ intention to spend. Their deal pipeline has some mega deals, including the recently won BP deal, which could provide fillip to growth in 2H and help them get closer to the upper end of guidance. INFO’s ability to expand margins in FY24 has been hampered by lower revenue growth and potential impact from large deal ramp ups. However, as growth normalizes, margins have potential to expand in FY25.

Wipro – No change in demand environment yet: 

WPRO indicated IT demand hasn’t deteriorated further in Q1, but hasn’t improved too. Q1 guidance of revenue decline of 1% to 3% cc QoQ bakes in the macro challenges. Banks are holding back on discretionary spend, Hitech and Telecom are seeing softness, though Energy & Utilities and Healthcare are resilient. WPRO’s Top 10 clients saw softness, driven by client specific issues, the impact of macro and project completions. WPRO expects margins to remain range bound as easing supply side is offset by lower growth and investments in reskilling of employees.

Mphasis – Pressure to continue in Q1: 

Given the high BFSI exposure, macro had a larger impact on its revenues relative to peers, also coinciding with client specific issues in verticals like Insurance, Logistics and Hi-tech. Although it has limited exposure to US Regional banks, large banks are looking to utilize their own resources before outsourcing. Sequentially, growth is likely to be weak in Q1 and accelerate as the year progresses. The recently announced eBECS UK acquisition should resolve DXC decline. MPHL is confident of delivering Ebit margins at 15.25-16.25% through FY24.

Coforge – Broad based growth momentum continues: 

COFO highlighted that growth momentum has continued into Q1, despite the macro headwinds. They reiterated confidence in achieving 13- 16% cc YoY revenue growth in FY24. The executable order book, growing at 21% YoY, provides visibility for growth with low probability of these orders being reduced in scope or size. The Insurance vertical should drive a more sustainable growth while BFS is coming off a high base and should moderate. Q1 margins will be impacted by wage hikes but it should improve over Q2 to Q4 similar to FY23.

Happiest Minds – Confident of achieving 25% growth guidance:

Deal singings and pipeline were strong in Q4, which has started getting converted to revenues. Management is confident of delivering a 25% revenue growth in FY24, which is largely organic, despite the macro headwinds. Happiest Minds ended FY23 with Ebitda margins of 26.2% and guided for 22-24% in FY24, despite the planned investments in talent, sales, and ramping up of large deals.