India IT Services - Strong Performance in Seasonally Weak Quarter - Reliance Securities

Q3FY22 Results Preview

In 3QFY22, the Nifty IT Index outperformed by 12% (CY2021 outperformance of 30%) to Nifty. We expect a continued strong revenue momentum on the back of deal ramp-ups, IT transformational spends and sustained deal closure activity across our IT coverage universe. We expect rising pressure on EBIT margin due to higher incentives for employees, wage hike to retain talent amid the high attrition, lower utilization due to aggressive fresh hiring, and stable SG&A cost. Recently, Accenture reported 21% YoY USD revenue growth in its outsourcing services business, which we believe is a key positive for the Indian IT names. Looking ahead, we expect the deal environment to remain robust backed by consistent technology spend on digital services by the global enterprises. We expect strong end-market commentary from the top-8 companies under our IT sector coverage universe. Despite December being a lean month in general, we expect healthy deal flows to drive the revenue growth.

Robust Demand Outlook and Digitalization to Accelerate Revenue Growth

We expect the IT companies under our coverage universe to report strong deal momentum (strong book-to-bill ratio and solid deal pipeline) across most verticals due to a strong demand seen for transformation and digitalization. We expect 3-4% and 4-5.3% sequential growth in CC revenue for the large cap and mid-cap companies, respectively. Further, revenue growth is likely to be broad-based across geographies and verticals. We expect deal bookings to remain strong, given the ongoing digital transformation trend.

Higher Attrition & SG&A to Impact Profitability…but Operating Leverage to Benefit; Stable Margins

We expect the companies under our IT sector coverage universe to report 10-40bps QoQ decline in EBIT margin due to: (1) accelerated hiring (both freshers and laterals) amid the high attrition; (2) marginal step-up in investment in sales and capabilities and (3) lower utilization due to hiring freshers. We highlight the margin pressure in 3QFY22, owing to higher employee incentives amid the rising attrition, while operating leverage and cross currency would nullify the impact to a greater extent. Thus, we expect a more or less stable operating margin. Though attrition would remain elevated, we believe that it has already peaked out now. Additionally, we believe the large cap IT names are in a better position to address supply side concerns compared to their mid-cap peers. We believe the accelerated attrition is likely to be a medium-term phenomenon, as we expect the demand environment to remain strong over FY21-FY24. Going ahead, we believe margin expansion would depend on: (1) improved pricing; (2) operating leverage (double-digit revenue growth); and (3) USD appreciation.

IT Names to Raise FY22 Revenue Growth Guidance & Maintain Margin Outlook

We expect the IT companies to raise their revenue guidance for FY22 on the back of a solid deal backlog and buoyant deal environment. We also believe a broad-based consensus exists among the large cap and mid-cap IT companies regarding acceleration in technology demand. We expect Infosys to raise FY22 revenue growth guidance to 17-17.5% (vs. the earlier 16.5-17.5%) and reiterate FY22 EBIT margin in the range of 22-25%. We expect HCLT to retain the CC double-digit revenue growth for FY22E and an EBIT margin range of 19-21%. We expect LTI to target to remain in the leader's quadrant in terms of revenue growth in FY22. We expect Wipro to guide 4QFY22 CC revenue growth of 2.5-3.5% (QoQ). We also expect accelerated disclosures/commentary on the progress of cloud business. We expect a decline in the utilization rate due to the fresher hiring and a rise in discretionary cost.

Key Focus Points

(1) Revenue guidance, 2) large deal pipeline/bookings, 3) WFH status due to increasing Covid cases, 4) IT budget of clients for the next year, 5) hiring intensity, and 6) attrition trend.

Our View

The IT sector (coverage universe) is set to post another quarter of strong growth with high CC growth and stable margins despite cost pressure, based on (1) increasing speed of digital transformation/shift to cloud, 2) improving deal pipeline, and 3) investment in the hyperscalers/SaaS ecosystem. We expect the IT companies to invest the margin gains that they witnessed in FY21 for capability addition and talent retention, which will aid their market share gain in the medium-term. We also expect accelerated disclosures/commentary on the progress of cloud business. Majority of global enterprises are still at an early stage of digital adoption, which is a huge opportunity for the Indian IT companies. Digital services business is likely to clock 15-20% CAGR in the medium-term, led by increased cloud adoption by the global enterprises. We expect the IT players to benefit from potential acquisition opportunities of captive units and vendor consolidation efforts. Currently, Nifty IT trades at >45% premium to Nifty on a 1-year forward earnings basis vs. the historical average premium of 7%. We expect multiple re-rating for select IT names, given their resilient operating model (low capex and high variable cost structure) and strong revenue growth visibility over FY21-FY24, which warrant a premium valuation. The stellar performance of Accenture has further strengthened our positive view on the sector.

Our Top Results Picks: HCLT, TechM and Infosys

Link to the report

Source : Equity Bulls

Keywords

Q3FY22 ResultsPreview ITServices India RelianceSecurities