IT companies expected to report muted Q3

Mumbai: India's technology-services industry, with the world's biggest by outsourcing market-share and number of employees, is expected to report moderate revenue growth in the seasonally soft December quarter amid increasing cautiousness among clients in the West, where accelerating debt costs and untamed inflation have shortened the odds on likely economic contraction.

Analysts ET spoke to said they expect companies to deliver median revenue growth of 1-4% quarter-on-quarter (QoQ), and 7-9% year-on-year (YoY). Bellwethers TCS, Infosys, and HCL are likely to report expansion in margins, while tier-two companies, such as LTIMindtree, KPIT, Persistent Systems, and Coforge, are expected to report strong quarters.

"Our recent conversations with the management of tier-1 companies indicated limited adverse impact on demand, although there will be softness in specific verticals, such as mortgage, retail, telecom, and hi-tech and Europe," said Mukul Garg, analyst at Motilal Oswal.

Motilal Oswal Financial Services expects its IT Services coverage universe to deliver median revenue growth of 1.9% QoQ and 9.1% YoY in constant currency terms.

By contrast, Mphasis may witness some growth moderation due to the impact on the mortgage business, while Zensar could deliver a revenue decline, led by broad-based headwinds across its portfolio.

"We expect IT companies to report growth moderation in Q3 on account of seasonal weakness and increasing caution among clients due to macro uncertainties," said Dipesh Mehta, an analyst at Emkay Global. "We expect revenue growth of 0.8-3.7% QoQ for tier-1 companies and of -0.4% to 3.4% for mid-cap companies."

Although improved utilisation, billable freshers, and favorable forex rates for some companies are likely to provide some margin tailwinds, the benefits will be offset in part by the adverse impact from furloughs and a higher proportion of cost take-out deals, said analysts.

"The pressure will come from weaker-than-expected revenue growth, lower utilisation QoQ due to higher furloughs, tail-end of wage pressures, higher travel, and higher sales & marketing spends," said Girish Pai, analyst, Nirmal Bang Institutional Equities. "While margins will improve on a QoQ basis for the entire coverage universe, we think they will disappoint vis-a-vis prior expectations."

Client budgets, incremental commentary on key verticals, deal pipeline composition, and pace of conversion will be keenly watched for assessing the near-term demand outlook, analysts said.

Major currencies, such as the Euro and GBP, remained stable against the USD, with EUR strengthening by 1%, while the GBP weakened by 1% in the December quarter.

Management commentaries after the September quarter earnings at some leading firms suggested divergent views across verticals, while acknowledging macro headwinds as the common theme. Commentary from companies in BFSI, life sciences, and communications verticals suggests higher optimism and resilience around tech spending, while retail and manufacturing verticals have highlighted more concerns around macro-led softness and focus on costs.

Some analysts said lower revenues could bring down the valuation of large IT companies.

"The risk for IT services stocks is continued revenue weakness in the second half of FY2023 followed by a tepid start to FY24," said Nitin Padmanabhan, analyst, Investec Securities. "This could bring down tier-1 growth expectations to 6-7% vs. 8% currently, leading to a potential contraction in PE multiples."