IT sector Q1 preview: Margins to remain under pressure, focus on guidance

The corporate result season for the first quarter of financial year 2022-23 is just around the corner. It will be kicked off by IT bellwether Tata Consultancy Services’ earnings on Friday, July 8.

If one goes by what analysts say, then the June 2022 quarter will be a mixed bag for the IT players where margins might remain under pressure, but rupee depreciation may provide some respite. "Management guidance on demand and recovery would remain at focus," they said.

Market participants believe that growth of Tier-I IT players is likely to be in a narrow range or muted, whereas Tier II players may outperform the largest peers. The growth deficit between the two is expected to narrow in 1QFY23.

The IT services universe should witness modest median revenue growth in 1QFY23E (up 3.3 per cent QoQ in CC terms and 14.3 per cent YoY). Growth in EBIT/PAT (-1 per cent/-2.8 per cent QoQ) should be impacted by wage hikes and supply-side pressure, despite a depreciation in the rupee against the dollar, said Motilal Oswal Financial Services.

It expects IT companies under its coverage to report muted performance on a quarterly basis, but on a year-to-year comparison, the bottomlime is likely to rise by 5.6 per cent. Even in the PAT, midcap IT space is likely to outperform the larger peers.

"We will be watchful of any moderation in the demand commentary across both Tier I and Tier II companies in the IT services space," it added. "While our recent discussions with management indicate continued momentum in spending on technology services, we expect initial signs of an impact in sectors like retail and manufacturing in 1QFY23."

Another brokerage firm Phillip Capital expects the June 2022 quarter to be a reasonably strong growth quarter for Indian IT players given the challenging macroeconomic scenario in the US/EU.

"Growth momentum is expected to continue with Tier-II players outperforming Tier-I players yet again," it added. "While supply side pressures will continue to weigh on margins, USD/INR depreciation is expected to offset it partially."

The IT sector has corrected significantly over the past six months, with Nifty IT correcting 28 per cent this year as against a 10 per cent decline in Nifty.

The stock price correction has largely been due to the derating of valuation multiples, as earnings estimates have mostly remained intact or seen minor downgrades, Phillip Capital added. "A weakening global macro environment has led to this correction" While the global macro fears are for real, we believe their impact on earnings will be minimal and temporary."

Motilal Oswal expects muted margins in 1QFY23 due to wage hikes and continued supply-side pressure as attrition is still elevated.

Among Tier I players, Tech Mahindra is likely to see the highest impact due to higher employee costs and seasonality, while the wage hike impact for TCS, Infosys and Wipro should be in a narrow range. HCL Tech should see some support due to seasonality in products and platforms, it said.

In the Tier-II pack, Cyient and Zensar Technologies would see a significant margin dip (-290 bp/-250bp) on elevated employee costs and weaker growth, followed by Larsen & Toubro Infotech and Coforge.

Attrition should remain at elevated levels and supply will continue to stay constrained, leading to elevated replacement costs. Higher intake of freshers will result in lower employee utilisation, which will constrain profitability, said the market analysts.

We see a limited change in the FY23 revenue growth guidance of Infosys, HCL Technologies, Coforge and L&T Technology Services.

Brokerages believe that valuations have corrected meaningfully in the last six months and have a positive stance on the IT service sector on the back of strong medium to long term demand outlook. Correction should be utilised to raise allocation to the sector, they advise.

Phillip Capital has selected TCS and Infosys from the large-cap space, whereas it has picked up Mindtree, Mphasis, Persistent, LTI and Coforge from the midcap space.

Motilal Oswal prefers larger IT players over the midcap peers given their relative valuation attractiveness and diversified client portfolio. It is bullish on Infosys, HCL Tech and TCS from the largecaps, whereas Mphasis and LTTS are its preferred midcap picks.

(Disclaimer: Recommendations, suggestions, views, and opinions given by the experts are their own. These do not represent the views of Economic Times)