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IT Services: Q4FY18 preview - Expect a steady quarter with FX tailwinds

Indian IT is expected to report a steady quarter, supported by currency tailwinds. We expect the sector to report a US$ growth of 2%-2.5% QoQ for Q4FY18. While INR is a marginal tailwind for the sector, USD has depreciated against GBP/EUR and this will be 80-100bps QoQ tailwind to reported USD growth. Margins will remain stable for the broader sector, Tech Mahindra (TechM) will see improvement in margins, in our view. Overall, we expect the sector to deliver INR Revenue/EBIT/PAT YoY growth of 4.4%/7.1%/3.2%, respectively. Guidance will be the key monitorable for the sector and will be the key driver for the share price performances of these companies in the near-term.

Expect a steady Q4FY18

December is a weak quarter impacted by furloughs and we expect similar seasonality to play out this quarter too. We expect Infosys/TCS/ HCL Technologies/Wipro to record sequential USD revenue growth of 2.0%/2.6%/2.6%/2%, respectively. TechM margin trajectory should continue to improve and we expect an improvement of 70bps QoQ. Mindtree should deliver solid 3.5% QoQ USD revenue growth with flat margins.

Guidance to remain in focus

Guidance from Infosys and HCL Technologies (HCLT) will remain in focus. This will be the first full quarter for new CEO, Mr. Salil Parekh at Infosys and clarity on his strategy will be one of the key monitorables. We expect Infosys to guide to 6.5%-8.5% USD revenue growth for FY19 and expect HCLT to guide for 8%-10% USD revenue growth for FY19 with stable margins. We expect Wipro (WPRO) to guide to 0%-2% like-for-like revenue growth for Q1FY19.

Demand commentary, specifically US BFSI and Retail, key driver

The demand commentary has been mixed from the large-caps and thus focus will be on spending outlook from in US BFSI and Retail given they have been laggards for the sector, particularly for large caps (TCS/Infosys). A conducive US macro environment, industrialisation of new technologies and US tax reform can drive an uptick in tech spending.

Maintain preference for TCS and Infosys among large caps

Despite the run-up in the sector over the past quarter, we continue to like the Indian IT space given our view, that the sector is likely to see cyclical uptick from improved tech spending in the US. We maintain our preference for players leveraged to this cyclical spending uptick (TCS and Infosys) and Tech Mahindra. Expect a steady quarter from MPHL and new deal wins will be key monitorable.