IT sector Q1 preview: Deal execution likely to pick up; margins to take hit

IT bellwether Tata Consultancy Services (TCS), India’s second most valued firm, will kick off the earnings season on July 8 with its first quarter results for the three months ended June 30, 2022. The IT major is expected to see an acceleration in revenue growth momentum on account of a pick up in deal execution but margins are expected to be impacted by annual salary wage revision effective from April 2022.

Domestic research firm ICICI Direct expects Indian IT companies to see uptick in growth during the April-June quarter of 2022, barring weakness in a few companies due to company specific events. “The deal execution normally picks up in Q1 as this is the first quarter of full execution after major/minor impact of furlough in Q3 and Q4, respectively. However, margins are expected to take a hit on a QoQ basis on account of annual wage hike cycle for a few while rationalisation of employee costs for others,” the agency says in a report.

As per the report, margin impact will also be on account of visa-related costs as well as an uptick in travel-related expenses as the economy opens up. The demand environment is expected to be strong due to continued deal momentum led by sectors like BFSI, insurance, etc., but macro as well as geopolitical scenarios would set the the tone for FY24 numbers.

TCS, Infosys, Wipro to post 2.5-4.5% QoQ growth

The report expects IT heavyweights TCS, Infosys, and Wipro to post constant currency (CC) revenue growth in the range of 2.5-4.5% on a quarter-on-quarter (QoQ) basis, while HCL Tech is expected to post muted growth of 2% on a sequential basis due to continued weakness in P&P business and also muted IT services business. It expects Infosys and HCL Tech to maintain their annual revenue and margin guidance.

Among others, Tech Mahindra is also projected to report 2% QoQ revenue growth due to seasonal weakness in its Comviva business. L&T Infotech is expected to post 3% QoQ CC growth factoring in absence of pass-through revenues (2-2.5% impact) for the quarter, while merger-bound Mindtree is expected to report 5% CC growth, driven by broad-based growth across verticals of travel, BFSI, insurance except for for retail sector. In May this year, the boards of directors of Mindtree and L&T Infotech (LTI) had approved a scheme of merger.

According to the report, these IT companies will face cross-currency headwinds in the range of 50-140 bps, which would negatively impact dollar revenue growth. TCS, Infosys & Wipro are projected to see dollar revenue growth of 1.5-3.5% QoQ, respectively. HCL Technologies is expected to witness dollar revenue growth of 1.4% QoQ, while LTI, Mindtree, and Tech Mahindra are pegged to see dollar revenue growth in the range of 2%, 4.5%, 0.7%, respectively, QoQ.

Wage hike, travel expenses to impact margins

As per the report, margins are seen contracting on a quarterly basis due to wage hikes and the continued rationalisation of employee costs amid high attrition despite the industry continuing to add record freshers. The attrition across companies would continue to be high and, hence, the cost to backfill attrition (at higher costs) and costs related to retention, bonus, rationalisation of compensations are expected to put pressure on margins, it noted. This quarter's margins also would be impacted due to an uptick in travel expenses as the economy opens up and visa-related costs. “We expect all IT companies to report a decline in Earnings Before Interest and Taxes (EBIT) margins sequentially in the range of 55-240 bps,” it added.

Key things to watch

During the quarter under review, key things to watch will be commentary on growth outlook and impact of macros on the tech spending of some of its big clients. Also, investors will keep a close eye on comments on hiring and attrition trends, margin outlook. The agency expects Infosys and HCL to continue with their annual guidance on revenue and margins. It does not expect Infosys to increase guidance for FY23 in this as well as subsequent quarters in FY23 which it used to do historically.