IT 2QFY11 PREVIEW: Key things to watch - Acceleration in growth trajectory, Discretionary traction, and Outlook on supply-side pressure
We expect continued momentum in 2QFY11 US$ revenues with growth in the range of 4.2-6% QoQ across top 4 IT companies. Infosys EBITDA margin is expected to recover 120bp QoQ while wage hike across HCL Tech and promotion impacts at TCS and Wipro will keep the margins curbed. Key expectations:
- Infosys to outperform on revenue growth with 6% QoQ growth (v/s 5.6% at Wipro and 4.7% at TCS)
- EBITDA margins at Infosys expected to recover 120bp QoQ to 32.9%. Promotion impacts at TCS and Wipro to curtail margins. HCL Tech margins to be hit the hardest on wage hikes becoming effective from July 2010
- Expect Infosys to marginally up its US$ revenue growth guidance to 20-22% (v/s 19-21% earlier); full-year EPS guidance to remain largely unchanged due to sharp rupee appreciation towards the end of the quarter
- Expect stock upsides if US$ revenue growth exceeds 7% QoQ; c172a50186a0284d25bbfa5e81f8aa
- We prefer playing the sector through companies gaining from pick-up in discretionary demand, c172a50186a0284d25bbfa5e81f8aa
- We prefer Infosys, HCL Tech and Mphasis on these parameters. Amongst the other top tier companies, we prefer TCS over Wipro.
- Infosys remains our top large cap pick, while Mphasis remains our top mid cap pick.
Performance snapshot: Infosys to lead revenue and earnings growth QoQ
Note: EBIT margins for Wipro are overall EBIT margins. IT EBIT margins expected at 23.6%, drop of 90bp QoQ.
Infosys to outperform on revenue growth after below-estimate 1QFY11
- We expect Infosys to post the best 2QFY11 results among the top tier universe with US dollar revenue growth of 6% QoQ, ahead of its guided range of 4.1-5.1%. We expect Infosys to beat peer group growth rates for the quarter.
- Wipro and TCS are expected to follow with 5.6% QoQ and 4.7% QoQ growth, respectively.
- Cross currency to positively impact US$ revenues; HCL Tech to benefit the most (0.8% impact of cross currency on US$ revenue), as over a quarter of the company’s billing happens in Euro/GBP.
- Growth is expected to be broad-based, led by BFSI, with improved traction in Manufacturing/discretionary service lines.
Infosys to outperform growth across top-3 – US$ revenue growth (QoQ) Infosys margins to rebound; HCL Tech, Wipro margins to decline
Infosys margins to recover; Promotions to impact EBITDA margins at TCS, Wipro
- We expect Infosys EBITDA margins to rebound 120bp QoQ to 32.9% after 230bp QoQ decline in 1QFY11; the recovery driven by: Sequential constant currency growth; c172a50186a0284d25bbfa5e81f8aa
- Impact of promotions at TCS to lead to 20bp QoQ decline in EBITDA margins to 29.1%.
- ~20,000 promotions in 2QFY11 and RSUs to select employees to drag IT Services EBIT margins down at Wipro by 90bp QoQ to 23.6%.
- We expect HCL Tech EBITDA margin to decline 210bp QoQ to 15.8%, taking largest hit across top-4 on account of wage inflation which became effective from the beginning of the quarter.
Expect upward revision in Infosys’ US dollar revenue guidance; EPS guidance to remain largely unchanged
- For FY11 we expect Infosys to give a US dollar revenue growth guidance of 20-22% (v/s 19-21% earlier).
- We expect EPS guidance to remain largely unchanged in this quarter on account of ~4% appreciation in the Rupee in the month of September.
- We expect Infosys and Wipro to guide for 4-6% QoQ growth in 3QFY11.
What will the stocks react positively to?
Top-tier IT stocks underperformed the Sensex over the past six months as business improvement was built into estimates, and valuations are 18.5-20x FY12E earnings. Absolute upsides from current levels will be driven by changes in guidance, commentary or results suggesting movement in growth trajectory from 20-25% range to 25-30% range. The key things to watch out for to ascertain this would be:
- Pricing up-ticks: Determinants of this will be: (a) growth skewed towards discretionary service lines like package implementation/products/
- Higher guidance suggesting shift in growth trajectory from 20-25% to 25-30%: We believe an increase in Infosys guidance beyond 22% could be a significant indicator of growth trajectory, moving to 25-30% quickly.
- Market share gains on impending deal renegotiations, where incumbents are MNC vendors. US$37b worth of deals are expected to come up for renegotiation over a few months. With most of the deals being Infrastructure Management Services (IMS) focused, a sudden acceleration in deal wins or deal ramp-ups in this service line would be keenly watched.
- Improvement in business traction in Europe and a shift towards longer term transformational deals v/s short term RoI focused deals, could lead to upsides.
We remain positive on the long term outlook of the industry; prefer Infosys, HCL Tech, Mphasis
- We expect IT demand to revive in FY11 with 19-25% volume growth and expect 2QFY11 results to reinforce this expectation.
- We prefer playing the sector through companies gaining from a pick-up in discretionary demand, c172a50186a0284d25bbfa5e81f8aa
- We prefer Infosys, HCL Tech and Mphasis on these parameters. Amongst the other top tier companies, we prefer TCS over Wipro.
- Infosys remains our top large cap pick, while Mphasis remains our top mid cap pick.
IT: Comparative valuations
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