IT Sector Q2 Preview: Revenue Growth Seen Muted, Large Deal Wins Guiding Light; Stocks To Buy

The IT sector is in focus ahead of its September quarterly earnings for FY24. India's largest IT firm, Tata Consultancy Services (TCS) will kick-start Q2 results season on October 10, followed by peers HCL Tech and Infosys earnings as well next week. Overall, the sector is expected to witness an incrementally better quarter than Q1, but nowhere close to what most players predicted at the beginning of the year. Revenue growth and margins are expected to be soft on continued macro uncertainties, while FY24 guidance is likely to be squeezed down owing to weak IT spending expectations. Strong deal wins will be the guiding light for the quarter.

Q2 Preview:

Subdued quarter:

As per HDFC Securities, the big news is that not much has changed in the past few months. Most of the demand indicators are trailing 10-15% below levels at the beginning of the year and only slightly better than the July lows; the supply-side factors remain favourable, supporting operational resilience despite soft growth. In Q2FY24, the IT sector is expected to deliver a soft quarter, although Q2 has historically been a seasonally strong quarter. Growth divergence is expected between companies, with tier-1 IT sequential growth ranging from -1.4% to +2.2% and mid-tier IT sequential growth ranging from +0.9% to 3.8%.

Further, the IIFL Securities preview note said the sector's CC revenues are expected to grow modestly at 1% QoQ in 2QFY24, with 30bps headwind coming from CC impact from A-Pac currencies. The brokerage said, "Continued macro uncertainty is leading to lower discretionary spending and slower deal ramp-ups. Midcaps (1.9% QoQ) will continue growing faster than large caps (0.5% QoQ) in 2Q."

Also, Incred Equities in its note said that it expects Tier-I IT services companies to post an average constant currency (CC) revenue growth of 0.4% QoQ and 0.3% increase in reported US$ terms in 2QFY24F, driven by continued softness in hi-tech and financial services (FSI) verticals and decision-making delay. The cross-currency headwind on the revenue could be modest, as the average USD has depreciated 1.1% QoQ versus the GBP while it has appreciated 0.1% vs. the Euro. For Tier-II companies, US$ revenue growth could average 2% qoq.

Meanwhile, IIFL's note added, "We expect sector Ebit margins to expand by 40bps QoQ, as annual wage hikes have been deferred by some companies amid easing supply-side. Net hiring is likely to remain soft in 2Q, as companies look to deploy previously hired resources and are finding it easier to increase just-in-time hiring. We will watch for i) 2H revenue and margin outlook, ii) deal-win momentum, iii) gen-AI investments by Indian IT, iv) attrition trends, v) strategy changes and competitive intensity, post the leadership churn, vi) capital allocation."

IT sector company-wise Q2 results:

TCS will be the first among IT companies to declare its Q2 earnings report on October 11. This Tata Group-backed flagship firm will be followed by HCL Tech and Infosys earnings on October 12. Furthermore, the L&T Group-backed L&T Technology Services will announce its Q2 on October 17, and LTIMindtree on October 18. Azim Premji-backed Wipro and Persistent Systems will declare their earnings on October 18. Tech Mahindra will announce Q2 earnings on October 25. Stocks like TCS, LTIM, Infosys and HCL Tech are looking to announce dividends for their shareholders as well during the day of Q2 results announcements.

HDFC Securities expects TCS, Infosys, Wipro, Tech Mahindra, and LTIMindtree to deliver sequential growth of +1.6%, +1%, -1.4%, -1% and +1.5%.In terms of margin performance, TCS and HCLT are likely to outperform, while the margins of LTIM and TECHM are expected to decline by 120bps and 75bps respectively.

In mid-tier IT, the brokerage expects Sonata Software and Persistent Systems to lead growth while Zensar is expected to lag. Further, it expects Infosys to retain its FY24E revenue growth guidance of 1-3.5% CC and HCLT to retain its revenue growth guidance of 6-8%. Meanwhile, Wipro can guide -1 to +1% QoQ CC for Q3FY24E, and LTTS is expected to retain its double-digit organic growth outlook.

Moreover, Incred's note said, that Tier-I companies led by Tata Consultancy Services (TCS), Infosys & HCL Technologies have announced multiple large cost take-out deals which should result in robust TCV bookings. Although managed bookings were soft (down 1.8% qoq and 17.9% yoy) for Accenture (ACN US) in 4QFY23, it expects overall bookings to grow yoy in 1QFY24F and has baked in a mid-to-high single-digit yoy revenue growth in its FY24F CC revenue growth guidance of 2-5%. GenAI demand accelerated for ACN and commentary from Indian peers remains a key monitorable.

In case of deal wins, JM Financial's preview note said, "Clients' cost focus is manifesting in efficiency-led mega deal awards. We believe large-cap India IT Services players have won a fair share of such deals. INFO appears to have taken a lead in 2Q, with at least three mega deals (TCV of c.USD 6bn), already announced. TCS' deal win momentum has sustained e.g. USD 1bn JLR deal. HCL announced a USD 2.1bn deal in Telecom. TECHM appears to be the only exception. We believe TECHM's excessive focus on margins currently is hindering its ability to bid aggressively. While that might aid margins in the near-term, it might impact FY25 growth adversely as efficiency-led deals seem to be the only game in town right now."

Also, JM Financials said, a likely soft 2Q and only a modest improvement in 2H should therefore induce guidance cut or moderation in the outlook for most, except Infosys.

It expects HCL to reduce its organic Services/Consol. revenue growth guidance by 2 ppt to 4.5%-6.5% and 4%-6% respectively. We expect Coforge to cut its guidance from 13%-16% to 12%-14%. We expect Wipro to guide for a 0-2% cc QoQ growth for 3Q. Players may however retain their margin guidance. Investors should also look for any signs of possible budget flush and indication of higher/lower impact of furloughs in 3Q.

IT Stocks To Buy Amid Q2:

Brokerage HDFC Securities said, "We increase estimates for HCL Tech and Infosys to factor better near-term visibility, supported by the ramp-up of the recent large deals, and roll forward target valuation to Sep-25E EPS. Maintain our selective stance on the sector; downgrade Sonata Software, Zensar Tech and Cyient to ADD (BUY earlier), given that the recent stock outperformance limits the near-term upside potential. Prefer LTIM among large caps and Persistent Systems and Birla Soft in the mid-tier IT space."

While Tech Mahindra continues to be Incred's preferred stock pick.

On the other hand, IIFL Securities prefer TCS and Infosys among large caps, and, COFORGE, Persistent and LTIM among mid-caps on better growth visibility. However, the brokerage maintained REDUCE on Tech Mahindra, Wipro and Mphasis.

Disclaimer:

The recommendations made above are by market analysts and are not advised by either the author or Greynium Information Technologies. The author, the brokerage firm nor Greynium would be liable for any losses caused as a result of decisions based on this write-up. Goodreturns.in advises users to consult with certified experts before making any investment decision.