IT - Q4FY22E Results Preview Report - HDFC Securities

Mr. Apurva Prasad, Institutional Research Analyst, HDFC Securities and Mr. Amit Chandra, Institutional Research Analyst, HDFC Securities.

Information Technology - Moderating, yet strong

IT index is up >40% (mid-tier >100%) over the past year, supported by (1) earnings upgrade of ~5% for tier-1 IT and ~20% for mid-tier IT and (2) IT index rerating from 23x to 28x. The absolute return potential for the sector is likely to be moderate (in line with earnings growth), basis: (1) growth reverting to medium-term baseline, (2) lower growth dispersion in FY23E as compared to FY22E, and (3) headwinds to multiple expansion based on increase in cost of capital & geopolitical risk premium, inflationary factors, and the lead-lag cycle of cost and pricing. The upside risk is on the longevity of high growth rate and downside risk is the second order impact from a prolonged inflationary environment and geopolitical dislocation.

Fundamental drivers for the sector remain intact (USD revenue growth of 14.5/12.5% estimated for FY23/24E as compared to 8.5% CAGR over FY16-22E), aided by (1) continuity of multi-year technology pivot across industries, (2) institutionalisation of operational efficiencies (structural higher offshore, fresher acceleration, training impetus), supported by increase in talent installed capacity, (3) lead indicators remaining robust - growth/outlook by global partners, services peers, hiring activity (TTM net adds > FY18-21 cumulative adds) and deal trends (>USD 60bn TCV booking in last 12 months by Top-8 Indian IT adding growth visibility). Incremental tailwinds is premised on: (1) pricing - benefits to accrue with a lag based on contract renewal cycle and with increase in scope, (2) INR depreciation (high historical correlation with IT index), and (3) increased offshoring and diversification of talent base from Eastern Europe by global enterprises.

There is some growth moderation from >4.5% CQGR over the past six quarters towards baseline levels - with sequential revenue growth estimated at 2.6% QoQ (including 30bps inorganic). However, Q4 revenue growth of 2.6% QoQ and 16.6% YoY remains well above the historical mark (1.7/8.2% QoQ/YoY 10Y average for fourth quarter) and incremental sequential revenue addition of USD 470mn (for tier-1 IT) is >2x the historical revenue adds. We prefer Infosys in tier-1 IT and Persistent and Mphasis in the mid-tier IT space.

WPRO, PSYS, TELX to lead growth in Q4FY22: In Q4FY22E, in tier-1, we expect TECHM to lead growth with 4.7% QoQ, supported by inorganic contribution of 2.7%, followed by WPRO with 3.2% QoQ growth, led by a recovery in Energy & Technology verticals and strength in BFS & Consumer. TCS, INFO, and HCLT are expected to post growth in the range of 1.6 to 2.6% QoQ, with HCLT impacted by P&P normalisation. Within mid-tiers, TELX/PSYS/MTCL are expected to lead growth at +8.0/7.9/5.3% QoQ. MAST, MPHL, LTI, and LTTS are expected to post 5%, 4.9%, 4.3%, and 3.3% QoQ growth. SSOF is expected to grow by 3% QoQ, supported by Microsoft portfolio, while CYL is expected to report a decline of 1.4% QoQ, due to a decline in the DLM business (-13% QoQ). TECHM, PSYS and WPRO will have 2.7%, 2.5% and 0.3% QoQ impact from acquisitions.

Key monitorables: (1) Guidance: INFO is expected to guide 13-15% CC for FY23E, TCS' deal bookings at USD 7.8bn for Q4, WPRO's Q1FY23E growth guidance at 2-4% QoQ, HCLT to extend double-digit growth outlook for FY23E, and LTTS expected to guide 16-19% growth for FY23E. (2) Deal pipeline/bookings (key deals included Cemex, Western Power, and Fletcher for TCS; Telenor for INFO; Continental Europe deals for WPRO, HCLT, and Airbus for LTTS). (3) Commentary on discretionary tech budgets trends. (4) Core vertical performance and outlook. (5) Supply side factors - attrition, fresher/lateral adds, sub-contracting and delivery mix.

Source : Equity Bulls

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