Indian IT to see margin contraction in Q1FY18 due to rupee appreciation

Wipro and Tech Mahindra to post poor results due to pressures in their respective verticals

The first quarter of a financial year is normally the most important one for the information technology (IT) sector; along with the second quarter, it gives the direction to the overall numbers for the concerned financial year. Given the moderate guidance for financial year 2017-18 (FY18) given by Infosys, other IT companies, and Nasscom, we believe that it will be a year of consolidation for the industry, with growth rates likely to be more or less in line with FY17 and a pick up expected by 2018. 

Earlier, in its guidance for FY18, Nasscom expected the IT industry’s services exports to grow 7-8 per cent in the financial year and the domestic IT services revenue growth was pegged at 10-11 per cent. 

However, on a long-term basis, the industry's growth potential can be around 10-11 per cent, given that Indian IT companies enjoy a market share of more than 50 per cent even after healthy growth over the past two decades, leaving enough room for the growth. 

Further, even at the current stage, Indian IT's core competitive advantage in terms of manpower cost is still intact and hence the industry has all the levers to increase its market share in the future. However, like any other industry, Indian IT companies are going through a transition with a shift occurring towards new technologies like digital. However, we don’t see this to be a worrisome sign. Instead, it is an opportunity that companies with management skills and leadership quality will be able to cruise through.         

For Q1FY18, Indian IT companies are expected to exhibit diverse trends. Among the large-caps, Infosys, HCL Tech, and Tata Consultancy Services (TCS) are expected to post constant currency (CC) QoQ growth of 3-4 per cent. Infosys is likely to post results at the lower end of the growth band, while HCL Tech will post a CC QoQ growth at the higher end aided by its acquisitions. 

On the other hand, Wipro and Tech Mahindra are likely to post poor results on the back of pressures in their respective key verticals.

On the currency front, since the euro and pound have appreciated against the US dollar, the reported dollar revenue growth will get a fillip, benefiting TCS, HCL Tech, and Wipro. 

The companies should witness a margin contraction, mainly on the back of rupee appreciation. However, the damage will be less profound for companies that have robust volume growth. 

Among the companies with low growth (Wipro and Tech Mahindra), we believe that Wipro should witness a QoQ decline in the margins, while Tech Mahindra should witness some stability in the margins as we believe that the last quarter witnessed bottoming out of the margins. 

Thus, we expect Q1FY18 results in the IT space to be robust in terms of volume growth. They will also set the stage for the rest of FY18 in terms of growth. Further, we don’t expect the industry to post any major deviations from the current guidance and hence there should be no surprises. Overall, we remain positive on the sector and maintain our buy on Infosys, Tech Mahindra and HCL Tech. The author is VP- Research, Pharma & IT at Angel Broking.