BoA ML: IT and BPO Services: 3QFY11 Preview India

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IT and BPO Services
Potential Result Outperformers: HCLT, Educomp
Potential Result Underperformer: Wipro


Strong rev growth for seasonally weak qtr
In a seasonally weak quarter with lower working days, we expect strong top-line
performance by IT services majors to continue, with a 5.5%-7% qoq growth in
USD revenue for the top vendors (vs 6-12% qoq last quarter). This builds in about
1% benefit from cross-currency. INR basis, reported revenue growth likely to be
lower at 2-3% qoq given ~4% appreciation of INR vs. USD in the quarter.

Currency led slight margin decline sequentially
Expect EBITDA margins to be flat to 60bps decline qoq for the top 4 vendors,
mainly on currency. Infy also expected to see some impact on account of
employee promotions this quarter, while for TCS, the 1x benefits in rents seen
last quarter should reverse, as expected. For HCLT, this is likely to be the last
quarter of currency led margin decline, in our view.
Commentary on demand likely to be positive
We expect hiring trends and commentary to be positive. We believe order flow
remains strong, driven by strategic and regulatory-related spending by the
banking, retail, and media sectors and cost-optimization-related spending by
industries like manufacturing. Risks of a macro-led slowdown have also abated
over the past few weeks, in our view, with positive economic data emanating out
of the US. Moreover, off-shoring continues to gain share in services like IMS.
Guidance likely to be tweaked up modestly
We expect Infosys to likely raise USD rev guidance by 1-1.5% for the full year,
while building in a modest 2-3% qoq growth for the March quarter. FY11 EPS
will also likely be raised only modestly by 1-2% , in line with company’s
conservative style.
Potential Outperformers: HCLT & Educomp; Wipro could
disappoint
We think HCLT should likely report the best quarter among peers, on highest
volume growth (7% qoq) led by enterprise app services and remote infra mgmnt
services. Wipro could marginally underperform on revenue growth due to its client
portfolio and fulfillment issues. At the EPS level, HCLT is expected to register
11% qoq growth vs. -2% to 2% for other three, on account of higher forex gains in
the quarter. Educomp is likely to show a strong 3Q given 3Q and 4Q are
seasonally strong. Expect ~7800 Smart Class adds, up 50% yoy. Expect EBITDA
margins to improve ~700bps QoQ to 45% driven by strong Smart Class adds and
recognition of 2nd tranche revenues from transfer of contracts implemented last
year. PAT growth of ~55% yoy likely.