Indian IT revenue growth moderates; supply side easing aids margin expansion - IT Q3 Preview

What's Buzzing 

IT companies’ growth for the quarter is expected to moderate on a sequential basis due to higher furloughs. Supply side easing, moderation of costs will likely help margin expansion albeit slightly. 

Context 

We expect IT companies to post QoQ CC revenue growth between 0.5% and 3.5% for Q3FY23. We expect HCL Tech (IT services) to grow 2.5% in CC terms leading the growth among Tier I IT companies while TCS, Infosys & Wipro are expected to report revenue growth of 1.5%, 1% & 1%, respectively. Among tier II IT companies, LTIMindtree is expected to report its first consolidated results after Mindtree’s merger with LTI. We expect it to report growth of 3% QoQ in CC terms. Among other Tier II IT companies, we expect Coforge and Tech Mahindra to report revenue growth of 3.5% and 0.5%, respectively, in CC terms. We expect cross currency headwinds to continue impacting the revenue of companies and expect the impact to be in the range of 20-50 bps on dollar revenues. We expect TCS, Infosys, Wipro (IT services) and HCL Tech (IT services) to post moderate dollar revenue growth of 0.7-2% QoQ while TechM, LTIMindtree and Coforge are expected to post revenue growth of 0.5-3.2% QoQ. We expect the companies to report margin expansion in the range of 10-70 bps QoQ except LTI Mindtree, which is expected to report a margin contraction of 200 bps QoQ on integration as well as higher furlough impact. 

Our Perspective 

Sequential growth in IT companies in CC terms is expected to moderate after strong growth in H1. Companies continue to maintain that they are witnessing weakness in tech spending in a few pockets of client portfolio i.e. BFSI (mortgage), retail, telecom, hi-tech, etc, which along with furlough impact will impact Q3 revenues. In our view, Infosys and HCL Tech are likely to maintain their revenue guidance of 15-16% and 13.5-14.5% in CC term for FY23 as the asking rate for H2 is not stretched, in our view. We also believe that considering the seasonally weak performance in H2, Infosys is likely to maintain this guidance for the rest of the year unlike previous years, where it had increased guidance in every subsequent quarter. The companies are witnessing moderation of attrition due to easing of supply and is expected to be a margin driver along with rupee depreciation for Q3. Moderation of some other costs like subcontractor costs, etc are likely to be medium term margin drivers. We expect EBIT margin expansion in the range of 10-70 bps for companies in Q3. A mix of cost take out deals has been inching up as far as deal nature is concerned. Pricing could be another lever for margin expansion but is expected to play out in the medium to long term as it is difficult to get a price hike in a subdued demand scenario, in our view.