IT Sector Q4 Preview: Soft Demand Trends To Keep Tech Companies On Their Toes, FY24 Exit Likely Weak

The blisters in IT companies do not seem to have a sooner relief, and Q4 is expected to be yet another wintry quarter, leading to a weak exit of FY24. Tech giants are lining up to announce their fourth-quarterly and full-year earnings report for FY24, with India's largest IT firm, Tata Consultancy Services (TCS) being the first to do so. Others will follow suit in the rest of April and May.

The IT sector suffers through moderation in new large deals, coupled with dull discretionary spending, continuation of furloughs and soft trends in demand. FY24 has so far seen bleak quarters, guidance cuts, and growth under pressure in segments like BFSI, and CPG among others.

In Q4FY24, Indian IT companies are expected to witness the continuation of soft earnings. Revenue growth is seen as tepid, while a slower pace of growth may take a toll on margins which is expected to further limit expansion. Overall, the March 2024 quarter is most likely to be sequentially weak.

Brokerage Kotak Institutional Equities is not expecting any significant improvement in revenue growth sequentially in the March 2024 quarter. Also, it believes gradual furlough reversals and elusive discretionary spending lead to a weak end to a forgettable year.

In its Q4 preview note, Kotak said, "Revenue growth in 4QFY24E is likely to remain tepid due to: (1) a weak discretionary spend environment and (2) furloughs continuing past 3QFY24."

Also, DOLAT Capital in its note said, "We anticipate another subdued quarter with Revenue growth of -1.5% to +1.4% QoQ in CC terms amongst our Tier-I IT names, and 2.3% to 4.9% CC growth for Tier-2 names for Q4FY24E, amidst delayed revenue conversion and muted demand environment. EBIT margin is expected to improve sequentially for most IT companies driven by cost optimization initiatives partially offset by sustained furloughs impact and will see QoQ movement of -50bps to +210bps in Q4FY24E."

Dolat's interactions with industry participants indicate BFSI and CMT continue to reflect pain esp. in the US led by a weak macro environment as well as cost cutting program.

Further, JM Financial believes that its large-cap coverage universe to report -1.8% to 1% QoQ cc growth. The reported USD print could be 20-30bps higher as crosscurrency has turned favourable. 4Q is typically impacted by lower billing days, although a leap year helps. Reversal of furloughs, a typical offsetting factor, has been slower this time.

On company-wise specifics, in the case of revenue growth, Kotak's note said, "Infosys' March quarter is seasonally weak, with 4QFY24 being no different-we forecast a 1.5% sequential revenue decline. Wipro, LTIM and TechM should also report a sequential revenue decline. HCLT (services) should outperform on
growth at 2.9% in c/c. TCS and HCLT will outperform on growth at 0.2-1.7% c/c qoq. US$ revenue growth will benefit from modest cross-currency tailwinds of 2-10 bps across larger peers and 5-43 bps at mid-tier companies."

Moreover, JM believes mid-caps are likely to outpace larger peers again. It added, "We expect KPIT (+4%) to report highest growth across our coverage. PSYS (+3%) and Coforge (+1.8%) should also fare better."

Meanwhile, in the case of margins, Kotak pointed out that IT companies continue to repair their cost structures, given the weak demand and moderating attrition and operating efficiencies, despite a lack of leverage from growth.

It added, "We expect reasonable margin improvement at TCS. The reversal of one-off impact from unprofitable contracts should benefit TechM. Wipro would have a moderate decline in margins, while HCLT's EBIT margin should be impacted by seasonal weakness in the products business. LTIM would be impacted by
lower utilization and partly offset by lower pass-through revenues qoq."

On margins, JM's note added, "Residual impact of wage hikes (one month for INFO, two months for WPRO), visa cost (INFO), lower software revenues (HCL) are specific headwinds. INR appreciation and muted top-line will weigh across players. Players have pulled most of the traditional levers - pyramid correction, utilization, sub-con optimization etc. While there could still be scope left, incremental margin expansion will likely be difficult in the absence of growth. Barring Coforge (+130bps QoQ), we see limited margin expansion among mid-cap companies as well."

Furthermore, for Q4 among Indian IT Tier-1 companies, DOLAT believes that TCS/HCLT/INFY should lead the way with 1.4%/1.3%/0.1% QoQ in CC while TechM/LTIM/Wipro is expected to see sequential decline of - 1.5%/-1%/-0.5% respectively. Among Tier-2, the brokerage believes LTTS should lead the growth with 4.9% QoQ, followed by KPIT (4.2%), Persistent (2.9%), Mphasis (2.5%) and Coforge (2.3%).

On the other hand, Nirmal Bang expects 4QFY24 to be a better quarter QoQ largely because of a higher number of working days.

On industry, key points to focus on in the Q4 quarter, as per Nirmal Bang are -- (1) Is spending worsening in 2024 compared to 2023 as Accenture has suggested in its 2QFY24 results? (2) when exactly will the growth kick in and what will be the driver of that (3) State of discretionary spending (4) State of demand
for key verticals - BFSI, Hi-Tech, Manufacturing & Telecom (5) How much of the recent demand slowdown is macro-driven vs normalisation of the high 'compressed transformation' demand seen in the pandemic timeframe? (6) How much are global capability centers (GCCs) eating into the business of outsourcing players? (7) Will there be a pent-up demand spike in FY26 that everybody is building into their estimates for FY26? (8) To what extent Gen AI has been used in improving internal productivity? (9) The extent and timing of salary hikes in FY25 (10) Whether hiring has resume.

Key points to watch in TIER-1 companies as per Nirmal are -- (1) Whether Infosys and HCLT deliver a 4-7% CC revenue growth guidance and how much of this is back loaded? (2) Whether the TCV to revenue conversion problem continues? (3) Status of mega/large deal ramp-ups.

Key points to watch in TIER-2 companies as per Nirmal are - (1) Mphasis - Is the mortgage BFS area healing? (2) Persistent Systems - Can it continue to deliver high TCV numbers? (3) Coforge - Will it repeat the revenue growth guidance of FY24 for FY25 with similar EBITDA margin?

Accordingly, FY25 is likely to see a timid start as well because global tech giants have already trimmed their guidance for this fiscal, hinting that tailwinds will continue in the sector.

BOB Caps in its note said, "We believe Indian IT companies are focusing more on improving operating metrics, such as pricing, productivity, utilisation, employee pyramid and portfolio mixes, as the cost optimisation deal wins are margin competitive in nature."

Kotak's note added, "FY2025E revenue growth outlook across companies is likely to be moderately better. We expect Infosys to guide for 2-5% revenue growth and HCLT at 4-6% overall (5-7% organic after excluding the impact of State Street JV divestiture). TCS should lead larger peers on growth. We expect Wipro to guide for revenues of 0.5% decline to 1.5% growth. We expect Infosys' EBIT margin guidance at 20.5-22.5% (up from 20-22% earlier) and HCLT at 18-19%."

Also, Kotak's note said, "We expect FY2025 to be a better year, although the intensity of improvement is lower than assessment six months ago. Large clients, especially banks, have the ability to spend, but the willingness is not there. We have cut our revenue growth forecasts marginally across our coverage universe. We expect a margin improvement in FY2025E as the full benefits of employee cost realignments bear fruit."

Lastly, JM said, "A weak exit to FY24 and a still inconducive demand environment could temper initial FY25 guidance for most players. We expect INFO to guide for 3-6% cc revenue growth for FY25. That could drive cuts to Street's current c.7% USD revenue growth expectations. HCL could guide for 6-8% cc growth. We see that as market neutral. Mid-cap guidance (Coforge/KPIT) could be in double digits, reflecting their sustained growth outperformance over large-cap peers.

To investors looking for IT picks, JM said, "NIFTY IT has given all its gains YTD, cushioning the downside. But expectations are still not low enough to allow for positive surprises. A weaker than expected guidance could change that. That would be a good entry point."

TCS will announce its Q4 earnings report on April 12, followed by Infosys and Mastek on April 18. Wipro is scheduled to declare its Q4 report card on April 20th, followed by Persistent Systems on April 21, Tata Elxsi on April 23, LTIMindtree on April 24, while LTTS, and Tech Mahindra earnings on April 25. HCL Tech will declare its Q4 on April 26 so far.

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