IT - Q4FY11 Result Preview - market share gains to continue, but no earnings upgrades anticipated :: Edelweiss

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As we head towards the end of a strong growth year for Indian IT—which began with a lot of uncertainty and ended with optimism—a perusal of the current environment hints at an encouraging outlook for tier-1 companies. Key demand vectors continue to be: (a) cost outs resulting in greater offshore embracement by the existing and new client base; (b) market share increase for domestic players in the renewal deal market; and (c) rise in discretionary spending. While the strong revenue growth story is intact, the street is already factoring in 25-30% growth in FY12 over FY11 for tier-I vendors. Interactions with industry players and channel partners suggest that CY11 client budgets will support FY12 growth at levels similar to FY11. So, while budget commitments are in place, the caution remains on spending as now budgets are periodically monitored to accommodate any macro economic developments i.e., the reaction time to macro is faster. Overall, Q4FY11 results are expected to be softer than earlier quarters, which may not lead to any earnings upgrade for the top-4 companies.

n  Infosys guidance: The next trigger for Indian IT?      

We expect Infosys to guide to 18-20% USD revenue growth and EPS of INR 138-142 for FY12. The revenue guidance range will imply a 3.6-4.3% CQGR through FY12E. This guidance assumes revenue growth of 3.4% for Q4FY11. On the operating margin front, Infosys is expected to guide down by atleast 100bps citing salary hike impact partly offset by pyramid broadening and utilisation improvement. However, any guidance of higher than 100bps decline should not be disappointing due to the company’s conservative margin guidance outlook (refer table 2) as has been the case in the past. Overall, the guidance is unlikely to result in upgrades as current street estimates have already build in a 25% USD growth and EPS of INR 150 with flat EBITDA margins.

n  March quarter results likely to be softer given the budgeting cycle

We expect most large companies to report 3-5% USD revenue growth for Q4FY11, lower than the atleast 6% growth posted in Q3FY11. Budget finalisation leading to slow project starts is likely to be the primary reason for this dip. INR/USD being slightly favourable during the quarter will add 1% to INR revenue growth and ~40bps to EBITDA margin. Margins are expected to be a mixed bag—rise for HCLT, Wipro and Infosys, while decline marginally for TCS as it continues to build capacity for growth in FY12.

n  Several operating margin levers to defend margins in FY12

While salary inflation impact on margins will continue in FY12, pricing, broadening of the employee pyramid and sales productivity are significant levers at the disposal of TCS, HCLT and Infosys. While sales productivity improvement due to client mining and large deal wins will aid margin defence/increase for TCS/HCLT, increase in utilisation will remain key lever for HCLT.

n  Outlook: Market share gains to continue

While the business outlook continues to remain strong, we believe the buoyancy in the environment is already factored in street’s estimates. Thus, we do not anticipate any upgrade in earnings in Q4FY11 for major vendors and stock returns over the next 12 months are expected to be driven by earnings growth of 17-22% in FY12. We continue to prefer TCS (BUY) over Infosys (HOLD) and HCLT (BUY) over Wipro (HOLD).  In mid caps we prefer Hexaware (BUY) and eClerx (BUY).