IT companies well positioned for strong Q3 growth on healthy deal momentum

Deal ramp-up, healthy pipeline and cost tailwinds to offset seasonally weak quarter

Indian information technology (IT) companies are expected to post another quarter of healthy growth despite the October-December period being seasonally soft and worries around intermittent lockdowns globally. Analysts expect the top companies to sustain healthy growth in the financial year 2021-22, as well.

Continued deal momentum, the ramp-up of large deals won during the first half of the current financial year, and cross-currency benefits are likely to drive earnings of technology companies in the recently concluded December 2020 quarter (Q3), say analysts.

“We estimate 2.5-3.5 per cent QoQ (quarter-on-quarter) dollar revenue growth for the top five players in reported terms, including a modest cross-currency tailwind (10-40 basis points or bps) from dollar’s depreciation against most major global currencies,” said CLSA in a recent report. 

Usually, Q3 is on the slower side because fewer working days and hence, smaller IT billing. However, analysts say, this trend failed to hold in FY21 as Covid-19 forced companies to look for ways to manage and grow business with the help of technology. This is evident in the large deal wins announced by domestic IT companies in the third quarter. 

“There have been at least five $100 million-plus total contract value (TCV) deal wins for our covered companies in Q3FY21, including an estimated $3.2 billion Daimler deal for Infosys,” said CLSA's analysts, adding that project/deal flow during Q3FY21 has been strong and their channel checks indicate heightened client conversations, especially in the life sciences, telecom, retail, and financial services verticals.

Margins or profitability, though, may see some pressure owing to revision in wages and large deal transition costs. However, the extent of contraction is expected to be limited owing to lower travel costs, cross-currency tailwinds, and stable pricing, say analysts.

TCS is set to report its earnings on Friday (January 8) and analysts expect India's largest IT services company to post 2-3 per cent revenue growth (in constant currency) on a sequential basis in Q3. 

“This will be led by continuing investments of clients in operational resiliency, cloud shift, and ramp-up of certain large deals,” said Kawaljeet Saluja, analyst at Kotak Institutional Equities. However, on a year-on-year basis, analysts expect a marginal revenue decline, indicating the impact of Covid-19 is still in play. 

Its profitability is expected to decline by 100-120 basis points on a yearly basis, primarily because of wage revisions from October 2020. “Besides wage revision, there are no other meaningful pressure points on margins,” said Saluja. The deal momentum remains strong as TCS bagged contracts from Deutsche Bank (€460 million) and Prudential ($300 million).

Analysts expect Infosys to report sequential revenue growth of approximately 3 per cent, aided by the ramp-up of the Vanguard deal and the acquisitions of BlueAcorn, Kaleidoscope, and Guidevision, and also upgrade its guidance. “We expect Infosys to increase its FY21 revenue growth guidance to 2.5- 3.5 per cent (from 2-3 per cent),” said Morgan Stanley. Meanwhile, margins may be flattish QoQ as revenue benefit and cross-currency benefits flow through while utilisation and offshore mix remain steady, offset by large deal ramp-up costs, say analysts.

Wipro may report 3 per cent revenue growth over the previous quarter driven by ramping up of large deals, such as E.ON, Marelli and John Lewis, won in the earlier quarters; profitability may see a marginal dip. “We expect (Wipro's) IT Services’ Ebit margin to decline 30 bps sequentially to 19 per cent because of promotions and salary hikes given to high performers (with effect from December 2020),” said Emkay Global. The domestic brokerage says the main things to watch out for are: Q4 outlook (we expect 1-3 per cent revenue growth guidance), demand trends in key verticals, and deal intake and pipeline, among others.

With a healthy deal pipeline and expected better IT spends because of an improvement in global growth, analysts expect better growth guidance for FY22. Part of these expectations for Q3 and FY22, however, are captured in the share prices.

IT stocks have had a dream run in the last 12 months, with the Nifty IT Index surging almost 60 per cent, against a 17.4 per cent gain for the benchmark Nifty 50 index.

“While valuations are near decade-high levels, high growth visibility and impressive cash flow generation mean the premium is justified,” according to Yogesh Aggarwal, head of research (India) at HSBC Securities. Aggarwal is revising the earnings per share estimates for large-cap IT companies in the range of 0.4-1.2 per cent for FY22.