IT sector Q2 earnings preview: New deals, guidance in focus amid deteriorating macros

The result season for the September 2022 quarter is all set to kick off from next week with IT majors like Infosys and TCS announcing their earnings.

Brokerage firms, however, do not expect them to report any surprise amid the economic gloom.

Majority of them remain skeptical over margins and profitability of the software exporters as the macro economic signs wane the hopes after mass layoff, despite positive management commentary and depreciating rupee.

The IT sector is expected to post resilient Q2 performance in context of the current macro environment. Mid-tier IT’s growth outperformance is expected to continue in Q2, the brokerage firms said.

Tier-1 IT companies are expected to deliver sequential growth in the range of 2.4-4 per cent constant currency. Cross currency impact severity will be similar to last quarter with -1.3 to -1.8 per cent sequential impact for Tier-1, said HDFC Securities.

Within the mid-tiers, Tata Elxsi, Mindtree, and Persistent are expected to lead at above mid single digit sequential growth, it said. "Supply-side normalisation can be construed as positive from the operational/margin perspective."

Despite the macro challenges in Europe, contracting activity remains strong, the brokerage said. "Accenture’s outsourcing bookings are at an all-time high and the top end of revenue guide also indicates demand resilience."

HDFC Securities is expecting a 242 basis points (bps) drop in the EBIT margins on a yearly basis for the larger IT players, whereas second rug IT counters may see a 1 per cent compression, taking the average hit on the entire sector to 228 bps.

Management commentary by Indian IT Services players has been positive post 1QFY23, but the street will be looking beyond this, particularly the guidance for the future.

Nirmal Bang Institutional Equities, which is underweight on the IT sector, said that most macro indicators in the developed markets have been deteriorating and many more customer verticals beyond mortgages and retail are stressed.

While we expect robust QoQ CC revenue growth for players under our coverage and QoQ margin improvement, the street is looking beyond this into what might transpire in 2HFY23 and FY24, it said.

Robust revenue growth expectation is based on the strong order intake momentum seen in the previous quarters, the analysts said. Significant cross-currency headwinds would restrict US dollar revenue growth.

"While margins may have bottomed out in 1QFY23, it remains to be seen how much of an improvement there will be on a QoQ basis as some companies would have implemented salary hikes fully or partially in 2QFY23," said Nirmal Bang.

3QFY23 commentary will be keenly evaluated as body language of almost all management indicates that it is not only going to be a seasonally weak quarter due to furloughs, but will also be impacted by the macro deterioration.

Dalal Street will be keenly looking at the total contract value for 2QFY23 and 2HFY23 deal inflow outlook with visibility is good and pipeline, along with inflation and energy challenges across the globe among others.

With a weakening macro environment and looming fears of recession, we will be watchful of any moderation in the demand commentary across both Tier I and Tier II companies in the IT Services space, said Motilal Oswal.

While our recent discussions with various management indicate continued spends on technology services, we expect some impact across sectors for the remaining part of the year, it said.

"The growth deficit in Tier I players versus Tier II peers will further narrow in 2QFY23," it added. "We see a limited change in the FY23 revenue growth guidance of Infosys, HCL Technologies, Coforge and L&T Technology Services given the unchanged demand commentary."

In the largecap IT space, HDFC Securities has a buy call on Infosys, whereas other four IT majors have an 'add' rating. In the midcap IT segment, Mindtree, Cyient and Sonata Software are a buy, whereas Tata Elxsi is a sell from the brokerage.

Motilal Oswal prefers Tier I players over their Tier II counterparts, given their relative valuation attractiveness and diversified client portfolio. Among Tier II IT stocks, we prefer Mphasis and L&T Technology Services.

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