Demand worries for IT companies

Q1 will be seasonally strong but impact of Brexit to keep stock prices under check

Rising concerns around Brexit and its likely impact on demand for the information technology (IT) services has hit tech stocks over the past week. In fact, stocks of the top four IT companies - Tata Consultancy Services (TCS), Infosys, Wipro and HCL Technologies - gave returns of 0.4 per cent-2.7 per cent in this period against 2.8 per cent in the S&P BSE Sensex. While the fall in euro, pound versus the dollar (or cross-currency movements) will have a bearing on the margins of these companies and dollar revenues, a bigger worry is on the demand side. As they make the transition to a post-Brexit climate, companies in UK, particularly in the banking and financial services sector, could trim their IT spends, at least in the near term. The trend could be similar in other industries in the UK and Europe. The top IT companies derive 7 to 13 per cent of their revenues in pounds and Europe forms 23-28 per cent of their revenues.

In this backdrop, it is not surprising that analysts have toned down their earnings estimates as well as target prices for these companies. Analysts at Kotak Institutional Equities, for instance, have trimmed their EPS estimates by 1-4 per cent and target prices by 4-7 per cent for these companies. These estimates could change further subject to the commentary of key managements on the extent of Brexit impact on their financials after June 2016 quarter results (Q1).

  The Q1 results of IT companies, though, will not reflect Brexit concerns, given that it happened in the last few days of the quarter. Q1 has traditionally been a strong quarter for IT companies. Analysts at Edelweiss Securities estimate the top four IT companies' sequential dollar revenues growth to be between two per cent and 6.6 per cent. They say Infosys will post highest organic revenue growth of 4.2 per cent on a sequential basis. However, wage hikes and higher visa costs will exert pressure on the operating margins, which could reduce by 100-170 basis points sequentially. Most analysts say Infosys will maintain its full-year constant currency revenue growth guidance of 11.5-13.5 per cent. The company has the lowest exposure to Europe and hence may be relatively better off than peers. Revival in Diligenta, TCS' UK-based insurance subsidiary, might get delayed thanks to Brexit, say analysts. TCS and HCL Technologies are more prone to Brexit issues, given their relatively higher revenue share from Europe.

Wipro is likely to lag peers' revenue growth in Q1 as well and, hence, despite undemanding valuations, most analysts are cautious on the stock.