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IT Services: Q3FY19 Preview - Seasonally soft, INR support continues

We believe Q3FY19E will be a soft quarter (a usual seasonal trend) for the Indian IT sector and estimate USD growth of 1.4%-2.8% QoQ for Q3FY19E. Q2FY19, on the other hand, saw strong deal wins and commentaries from Tier-1 IT companies. Although cross-currency (CC) growth is expected to moderate a bit, a 3-4% QoQ average depreciation in INR would result in superior Rs-EPS growth. Investors are likely to lookout for industrialization of digital services, and we see participation of Indian IT companies in this space. TechM could deliver a better quarter supported by strong deal wins in the communication vertical in Q2FY19. Overall, we estimate INR Revenue/EBIT/PAT YoY growth of 17%/22%/17%, respectively. We do not expect any material changes to Infosys and HCL Technologies’ (HCLT) CC guidance.

Q3FY19E will be seasonally soft, as expected; TechM to improve growth trajectory

Dec is typically a weak quarter, impacted by furloughs and we expect similar seasonality to play out in Q3FY19E, We expect USD revenue growth of around 1.4 %-2.8% for our IT pack universe. We estimate a CC impact of 50-60bps for companies within our universe, as most currencies have moved in a narrow range during 3Q. We expect Infosys/TCS/HCLT/Wipro/TechM to record sequential USD revenue growth of 1.4%/1.5%/2.8%/0.7%/2.0% respectively. HCLT and TechM should outperform this quarter in terms of CC growth, given large deal ramp-ups (HCLT) and seasonal strength in communications for TechM, respectively.

No material change to CC guidance expected

We do not expect either Infosys or HCLT to adjust their guidance for FY19. Wipro (WPRO) will likely guide like-for-like revenue growth of 1%-3% for Q4FY19E, in our view. Focus will be on client budgets for CY19 and demand outlook in the US – particularly in BFSI and retail.

We await commentary on demand & outlook for the digital business

US BFSI and retail have shown strength over last 3 quarters, either through deal wins or revenue growth or both. Additionally, we would focus on industrialization of digital and increase in deal sizes. Nifty IT index underperform Nifty by 9% as against an outperformance of 22% in CY2018. We have marginally adjusted our estimates to factor in the quarter as well as currency movements. Valuations of midcaps look expensive, and we would continue to prefer large caps. We maintain our preference for players leveraged to uptick in cyclical spending (Infosys/TCS). Infosys management had brought focus towards larger digital play & has shown momentum of large deals. Attrition will be a key factor to watch for Infosys. While TechM looks attractive on reasonable valuations and as a levered play in telecom, we remain cautious on HCLT and Wipro.