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IT Services: Q2FY19 Preview - Steady CC performance with INR support

We expect the Indian IT sector to report a good quarter with steady constant currency(CC) performance and INR depreciation. Cross currency movements will weigh on USD growth. We expect the sector to report US$ growth of 1.5%-2% QoQ for Q2FY19E. While INR is a substantial tailwind for the sector, USD has appreciated against GBP/EUR, which would have a 80-120bps QoQ impact on reported USD revenue growth. With good CC growth and 4% average INR depreciation QoQ, we except margins to improve sequentially across the sector. Tech Mahindra (TechM) should see recovery in the telecom vertical, while Mindtree (MTCL) is expected to outperform. Overall, we expect the sector to deliver INR Revenue/EBIT/PAT YoY growth of 15%/20%/15%, respectively. We do not expect any material changes to Infosys and HCLT’s CC guidance.  

Expect a good Q2FY19E

USD movements will impact reported revenue growth but CC growth will remain steady for the sector, in our view. We expect Infosys/TCS/ HCL Technologies/Wipro to record sequential USD revenue growth of 1.8%/1.9%/1.4%/0.7%, respectively. TechM would see a negative impact in the Enterprise segment (led by healthcare) but recovery in the Communications vertical should offset the impact; we estimate 1% USD QoQ growth in TechM. MTCL should deliver solid 3.5% QoQ USD revenue growth with 247bps margin improvement. 

No material change to CC guidance expected

We do not expect either Infosys or HCL Technologies (HCLT) to adjust their  guidance for FY19. We estimate Wipro (WPRO) to guide like-for-like revenue growth of 0.5%-2.5% for Q3FY19E. However, we expect a more positive margin commentary from companies (Infosys in particular), given the INR tailwind.

We await commentary on demand; estimates raised for FY20E; FY21E introduced

US BFSI and Retail have been laggards in the sector, particularly for large caps (TCS/Infosys). Companies have been pointing to these segments bottoming out  and we would look for more clarity if spends recovering. Additionally, we would also focus on large deal wins by players like Infosys. We have raised our Rs-EPS estimates across the sector to factor in weaker INR for FY20E, and introduced FY21E estimates. For FY20E, we have upgraded our EPS estimates by 1%-4%. Our target multiples remain unchanged, as there is little upgrade to our CC revenue growth numbers.

Maintain preference for large caps

We have seen continued outperformance with CNX IT index outperforming Nifty by 11% this quarter. We believe valuations of mid caps are expensive, and continue to prefer diversified large-caps. We roll-over our target prices to Dec 2019 and maintain our preference for players leveraged to the cyclical spending uptick (Infosys/TCS). TechM remains a levered play in telecom.