IT - Q3FY12 Result Preview - Near-term slowdown:: Edelweiss

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Q3FY12 performance is expected to be subdued due to lower working days and higher-than-usual annual shutdowns and furloughs. We believe decision-making has slowed down and ramp ups are behind schedules. Inflation-linked pricing hikes have been denied. Revenue growth in Q3FY12 is expected to slow down to 2-3% QoQ from the earlier expectation of 4-5% in USD terms. But INR depreciation is likely to aid earnings growth. Infosys is likely to raise its FY12 EPS guidance from INR145 to INR150 due to the INR depreciation, but we believe commentary on decision making, IT spending in CY12 and pricing will be cautious. We prefer TCS, HCLT and Hexaware.

Management commentary ‘cautiously optimistic’

Q3FY12 started on a positive note with September and October being good months. But decision making lost steam in the latter half of Q3FY12. Infosys indicated that discretionary projects have to go through multiple levels of approvals, delaying decision making. Also, ramp ups are behind schedule. The quarter also experienced higher days of annual shutdowns and furloughs in the hi-tech manufacturing sector. Even pricing commentary has changed with inflation-linked pricing increases, which were possible till H1FY12, being denied in Q3FY12. Thus, commentary on business has moderated, although, optimism on a strong FY13 remains.            

INR depreciation to aid earnings growth

Revenue growth in Q3FY12 is expected to moderate to 2-3% QoQ from the earlier expectation of 4-5% in USD terms, both due to lower volume growth expectation as well as USD appreciation against other currencies. But the INR depreciation of 11% QoQ is expected to aid margins. We expect Infosys’ EBITDA margin to record a seven quarter high of 34%. TCS’ EBITDA margin at 31% will be the highest since FY01. Thus, tier-1 IT companies are expected to report 32% YoY growth in EBITDA. For mid caps we expect revenue growth of about 2% QoQ in USD terms and EBITDA growth of 52% YoY.   

Prefer players with good order books—TCS, HCLT and Hexaware 

We had revised down our FY13 revenue growth expectation for tier-1 IT stocks (Read our report IT – Growth moderating, dated 22^nd December, 2011) but raised earnings 1-8% due to assumption of INR 50/USD compared to INR 46/USD earlier. In mid caps, we are now cutting our FY13 USD revenue growth forecast marginally from about 20% earlier to 18‐19%, but raising earnings 3‐11% due to the INR depreciation. In the backdrop of a slowing volume growth and risk of pricing pressure in FY13, we prefer players with good order books built on back of large order wins in the past few quarters. Thus, we prefer TCS, HCLT and Hexaware and maintain ‘BUY’. We remain cautious on Infosys due to its exposure to short-term projects and discretionary spending and Wipro, due to risk of disappointment given the expectation of an improving revenue growth trajectory and hence maintain ‘HOLD’.