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Q2 IT Preview: Double-Digit Revenue Growth Expected, Margin Pressure May Sustain

Top Indian IT firms could report double-digit revenue growth in the second quarter ended September, according to analysts.

<div class="paragraphs"><p>The Tata Consultancy Services building. (Source: Company PR)</p></div>
The Tata Consultancy Services building. (Source: Company PR)

Previous deal wins, cloud migrations and digital technologies could drive revenue growth for the Indian IT sector in the July-September quarter, but supply-side challenges and cost pressures may weigh on margins, according to analysts.

India’s top five information technology companies by market capitalisation—Tata Consultancy Services Ltd., Infosys Ltd., Wipro Ltd., HCL Technologies Ltd. and Tech Mahindra Ltd.—are expected to report double-digit revenue growth in the second quarter, according to a survey by Bloomberg.

TCS, Infosys and HCL Technologies could see quarterly net profit rising between 5-12%, whereas Wipro and Tech Mahindra may see a decline, the survey indicated.

"We forecast a solid 2.5-4.7% sequential revenue growth for large players for the September 2022 quarter," according to Kotak Institutional Equities. However, the EBIT margin should remain under pressure as companies deal with supply-side challenges and elevated costs, it said.

According to Nomura, the Indian IT commentary will likely turn more cautious in the second quarter, as compared to the first quarter, in light of higher risks emerging from the worsening macroeconomic situation—particularly in Europe.

According to the Bloomberg consensus estimates, in the second quarter, TCS may see a year-on-year constant currency growth of 14.27%. Wipro IT services' constant currency growth is likely to be 13.26% year-on-year.

HCL Technologies will most likely see a constant currency growth of 3.11% on a quarter-on-quarter basis, according to Bloomberg.

Is Margin Recovery On The Cards?

While wage pressure continues to limit margins, an improving pyramid, operating leverage and pricing will lead to a slight 30 basis points margin recovery in the quarter ended September, according to Jefferies.

“We expect aggregate EBIT margins to recover slightly by 30 bps QoQ in 2Q FY23 after falling by 165 bps in 1Q FY23,” it said.

The brokerage also expects wage hikes at HCL Tech, Wipro, Tech Mahindra, and Mindtree; continued supply-side pressures; and higher travel costs to weigh on margins.

IDBI Capital said that post the wage hikes by large caps, margins have bottomed out and are expected to witness 7-155 bps sequential improvement in the second quarter.

Mid caps are expected to witness 72-94 bps decline led by wage hikes and attrition, the brokerage said.

Nomura said that sustained supply-side challenges owing to high attrition, higher-than-usual hikes for onshore and offshore employees, and some resumption of discretionary spending like travel would continue to delay a significant improvement in margins despite weakening currencies.

The first quarter EBIT margin of 23.1% is likely the trough for fiscal 2023, it said.

"We expect 24.3-24.8% EBIT margin in FY23-24F vs 25.3% in FY22."

Cross-Currency Headwinds

Additionally, cross-currency headwinds will likely be strong, with a negative contribution of about 80 to 200 basis points, Nomura said in its investor note.

Meanwhile, Morgan Stanley flagged a "steep" cross-currency impact of 90-320 basis points, dragging reported dollar growth to 0.5-3.7% for large caps and 2.6-9.6% for mid caps.

The cross-currency movements may also negate the positive impact from the fall of the Indian rupee against the U.S. dollar, Nomura said.

According to it, mid caps could continue to benefit more from the rupee's fall against the dollar, due to their lower exposure to EU currencies in relation to large-cap companies.

Meanwhile, Kotak said it expects no meaningful growth, on a rolling 12-month basis, in the total contract value for the IT companies, except Mindtree.

IT Companies' Guidance

Analysts do not expect any change in guidance from Infosys and HCL Technologies.

In the first quarter, Infosys had guided for 14-16% revenue growth in fiscal 2023, while the margin was expected at 21-23%.

HCL Technologies, in the previous quarter, had said it expects revenue to grow between 12-14% in constant currency, while EBIT margin is expected to be between 18-20%.

According to Nomura, the near-term revenue growth outlook for this fiscal remains strong, though uncertainties have emerged significantly on the fiscal 2024 growth outlook.

The brokerage expects a 2-4% constant currency revenue growth guidance from Wipro, while IDBI Capital expects Wipro to guide for 0-2% growth in the third quarter.

Stock Movement

In the quarter ended September, the Nifty IT Index fell nearly 3.10%, dragged by Mphasis Ltd. (down 9%), Tata Consultancy Services (-8.04%), Wipro (-5.24%), Coforge Ltd. (-5.01%) and Persistent Systems Ltd. (-4.72%).

Only three of the Nifty IT constituents, L&T Technology Services Ltd. (+18.5%), Larsen & Toubro Infotech Ltd. (+12.13%) and Tech Mahindra (+0.86%) gained over the period.

The Nifty 50 gained 8.33% during the period.