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IT Services: Q2FY20 Preview - Growth surprises look unlikely

INFO/HCLT to lead on margin improvement; INFO to lead on growth; WPRO to lag

We expect top-4 IT to post CC revenue growth of 3.3% q-q (ex of ~90bp from HCLT IBM IP acquisition it is inline with 1Q). We see EBIT margin improvement of 90bps q-q and decline of 170bps y-y to 21.6% and flat PAT growth on a y-y basis. INFO is expected to lead growth (3.3% q-q), followed by TCS/TECHM (2.6-2.7% q-q) with HCLT/WPRO (lagging on organic growth at 1.4% q-q). HCLT/INFO could likely lead on EBIT margin improvement (~110bps q-q) followed by TECHM (~90bps q-q) and TCS (~60bps q-q) led by limited incremental wage hike impacts, lower visa costs and benefits from IP acquisition at HCLT.

See FY20E growth guidance upgrades at INFO and HCLT; risks to growth at TCS

FY20E guidance could be raised at INFO to 9-10.5% y-y (vs 8.5-10% y-y earlier) and HCLT to 15-17% y-y overall vs 14-16% y-y (~7.5-9.5% organic). At TCS, given weakness in BFSI/pushback in Retail and deceleration in manufacturing, coupled with high dependence on Europe (where macro weakening is more pronounced) we see risks to consensus growth expectations. We expect WPRO to guide for 1-3% q-q growth for 3QFY20 and HEXW to retain guidance of 19% y-y growth (12.3% organic). We expect HCLT/INFO to reiterate EBIT margin guidance of 18.5-19.5%/21-23%.

INR depreciation to be a marginal benefit as negative CC moves offset

In 2Q, average USD-INR depreciation is ~1.2% q-q to ~70.5 levels. However, negative CC impacts across top-5 IT (~70-90bps) would likely counter INR depreciation leading to minimal positive impact on margins.

Key to watch: Sector wise – We remain cautious on BFSI, manufacturing and Europe

• Outlook and performance in BFSI where there is near uniform caution on capital markets, Europe and US regional banks. BFSI is nearly one-third of top-4 IT revenues.
• Any moderation in Europe, where business confidence indicators are falling, PMI’s are in contraction and issues with BFSI and Auto are centered. Further, there is uncertainty around Brexit.
• Outlook in manufacturing and retail, wherein manufacturing components (auto and hitech) are showing weakening client financials and retail where companies are hopeful of a rebound is key to watch.
• Any increase in legacy drag on margins as customer focus on costs would be key to watch.

Key to watch: Company wise - Prefer HCLT/INFO over TCS/WPRO.

• INFO: Does INFO stay immune to client specific issues and raises guidance (given ask rates are just 1.5% CQGR over 2Q-4Q to meet top end of guidance, ex of Stater deal)?
• TCS: Can it show strong deal wins to ensure good exit rates in FY20E, else consensus FY21E growth expectations could be at risk? BFSI and Europe outlook is key given high growth dependence.
• WPRO: Weaker than 1-3% q-q growth in 3Q could be taken negatively. To ascertain whether WPRO will play disruptive to drive growth, its margin performance and outlook is key to watch.
• HCLT: No raise in guidance despite near zero sequential growth requirement to meet top-end of its guided band of 16% growth in FY20E, will be taken negatively.
• TECHM: Expect risk to mid-single digit growth guidance in Enterprise weak near term traction. Key to watch is whether better growth in telecom comes at the cost of margins.
• MPHL: Can the company belie concerns on DXC channel growth, while showing sustained momentum in Direct Channel? Exhibiting the same could lead to a re-rating.
• HEXW: Can it meet its CY19 guidance given steep asking rate of 6.5% CQGR over 3Q/4QCY19 (adjusting for mortgage client ramp-down)? Strong deal wins key to sustain growth in CY20E.

View: We stay selective in the sector, prefer players with 1) low expectations and reasonable valuations, 2) possibility of guidance upgrades and 3) low external demand dependence. Prefer HCLT and INFO among large caps and MPHL within mid cap IT. Pecking order: HCLT > INFO > TECHM > TCS > WPRO.