Religare:IT Services: Q2FY11 Preview: Strong quarter ahead

IT Services: Q2FY11 Preview: Strong quarter ahead; expect Infosys to outperform peers

We expect a strong Q2FY11 from Indian IT with ~7% volume growth from large
players, stable pricing and flattish margins, with the exception of Infosys which is
likely to report margin improvement. Infosys is expected to post a strong
quarterly performance, ahead of other large cap players, which could lead to
stock outperformance in the near term. For HCL Technologies, we remain
positive on a longer-term horizon but expect margin pressures this quarter due
to wage hikes, which could lead to a weak performance. On a fundamental basis
while the near-term growth remains intact, we continue to believe that share
price upsides are limited given full valuations and already high expectations.
Strong Q2FY11 ahead: We expect a good Q2FY11 driven by robust volume
growth as this is traditionally the strongest seasonal quarter with the highest
number of billing days. We believe that IT companies will deliver strong QoQ
volume growth of 7–8% and that Infosys and TCS will report rupee revenue
growth of 10%/7% and dollar revenue growth of 8%/7%. We expect margins for
TCS and Wipro to remain largely flattish, while Infosys is likely to show a
~200bps QoQ improvement. We estimate EPS growth of 18%/9% QoQ for
Infosys and TCS respectively. We believe that managements would guide to ~5%
revenue growth in Q3FY11, with commentary focused on discretionary spend
trajectory and supply side pressures.
Potentially picture-perfect quarter for Infosys: We expect Infosys to report strong
dollar revenue growth of 8% QoQ driven by volume growth of 8%. Further, the
company’s EBIT margin is likely to expand ~200bps largely due to volume growth
and improved utilisation. We expect Infosys will raise its revenue guidance for
FY11 by 3.5% in dollar terms and 2% in rupee terms and EPS guidance could be
raised to Rs 116–120. We note that consensus is already at Rs 122.
Stock recommendations: We believe that Infosys/TCS/Wipro, which are currently
trading at 21x/19x/18x FY12E earnings, are already fully valued given the
expected EPS growth of 15–20%. However, for investors willing to play the
near-term trade, we expect Infosys to outperform its large cap peers given the
stronger quarterly outlook. While HCL Tech is likely to have a soft quarter owing
to margin pressures from wage hikes, we remain positive on the stock from a
valuation standpoint.