IT SECTOR

Q4FY13 Preview Sector Preview:

Q-o-Q Revenue growth to be in line with estimates, cross currency movements to impact the revenues to some extent
We expect most of the IT companies to report in line Q-o-Q revenue growth in Q4FY13. Tier-I IT services companies are expected to report a USD organic revenue growth of 23.5% Q-o-Q with TCS & HCLTech likely to lead the pack. Wipro is likely to grow at the lower end. Infosys could also grow at the upper end, mainly supported by Lodestone acquisition. However, its organic growth is likely to be lower than TCS & HCL Tech. The 3.3% average depreciation of GBP vs USD during the quarter could impact the Q-o-Q USD revenue growth of Tier 1 companies by 20-50bps. TCS, Wipro & HCL Tech are likely to have a greater impact due to higher revenue bookings in GBP (~15-16%). However, Infosys would be marginally impacted by the cross currency headwinds. Among the Tier II players, cross currency movement is likely to impact Tech Mahindras Q-o-Q USD revenue growth significantly, since the company has ~38-40% of the revenue bookings in GBP. Nasscom expects dollar revenues to grow 12-14% in FY14E. It stated that the demand environment is far more positive now as compared to a few months back. It said that the customers are starting to converse on strategic investments and hence guidance appears realistic and achievable. We feel Q4 results and commentary on outlook from the Tier I IT players could set the tone as it could give a clear indication of a potential revival in demand. However, we dont expect any positive surprises on the revenue front in Q4, except in case of Wipro, where the expectations are the lowest.

April 11, 2013

Operating Margins to be under pressure

Margins of the top IT companies (leaving Wipro) are likely to be under pressure largely due to cross currency headwinds, onsite wage hike and promotions (in case of Infosys), claim settlements (TCS) and higher investments in S&M (in case of HCL Tech). However, the utilisation levels of most of the large cap IT players are expected to improve, as we expect the fresh staff hiring to remain muted. This should limit the extent of moderation in margins. Further, a stable INR vis--vis USD (average rate: 54.17 in Q4 vs. 54.14 in Q3) is unlikely to be a margin headwind like in Q3. Among Tier-II companies, margins of Hexaware could expand on the back of a low base of the last quarter, wherein the margins had declined significantly. However, Tech Mahindras EBITDA margins could fall due to cross-currency headwinds, full-quarter consolidation of Comviva acquisition and absence of high licensing revenues of Comviva.

Focus will be on the Managements Commentary on IT sector outlook

The market participants would closely focus on the managements commentary on IT sector outlook for CY13. Most of the companies have indicated improvement in deal pipeline in the last few months. However, faster ramp up of the deals is essential. Outlook & commentary on clients budgets for CY13 would be a prime focus. The IT stocks (large caps & selective mid-caps & small caps) have run up sharply in anticipation of improvement in spending in CY13. Hence converting IT budgets into spending and translation of positive sentiments into revenue has become critical, since the street expectations as regards FY14 revenue growth are high. Outlook on discretionary spending would be crucial from the growth perspective. Clarity on fresh hiring would also be keenly watched given HCL Tech fiasco. For Infosys, commentary on CY13 outlook and progress towards its new strategy would be crucial. For TCS, road map for growth sustainence for rest of the year & view on business ramp ups would be crucial. On an overall basis, some of the key things, which would be tracked closely by the market participants include:

Outlook on client spending (discretionary / non discretionary) and project ramp ups in top clients. Comments on demand and pricing trends in financial services vertical. Key verticals/Geography growth/de-growth expectation Clarity on fresh hiring Margins trajectory. Demand environment in Europe and Continental Europe. Commentary on protectionism and strategy to handle it.
1

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IT index has outperformed the Sensex in Q3FY13, better than expected Q4 results could result in further upside
BSE IT index had underperformed the broader markets in Q3FY13 on the back of hazy outlook of US & European economies and expectations of subdued Q3 numbers. However, there has been a turnaround in the sentiments over the last three months. The BSE IT index gained around 21% in Q4FY13 (Jan-March), thus outperforming the Sensex, which actually declined by 3% over the same period. This outperformance of IT index has been on better than expected Q3FY13 results reported by most of the IT companies (especially the large caps) and in anticipation of revival in spending in the coming months. Large caps like Infosys, TCS, Wipro & HCLT have delivered returns in the range of 11-29% (with HCL Tech being a top gainer and Wipro gaining the least) during the quarter. Despite such a sharp run up, the valuations of most of these players dont look stretched. There is still some room for further upside in the event of better than expected Q4 results and optimistic commentary on the sector outlook. We feel going forward the focus of the IT companies will now shift to cost rationalisation, productivity & efficiency of employees and utilisation from concentration on volumes. There is a possibility that some of the large IT players could announce changes in their policies of utilizing free cash by higher distribution in the form of dividends/buybacks. This would help the IT companies to report better return ratios. The anticipation of such transformation taking place or better than expected Q4 results could lead to more upside in IT stocks. Particulars (Rs. In Million) Infosys Net Revenue Operating Profit PAT (Adjusted) Quarter End Q3FY13 104240.0 29700.0 23690.0 Q4FY12 88520.0 Sequential USD revenue growth could be 3.8-4% Q-o-Q, which would be supported by full quarter benefit of Lodestone acquisition. Organic growth is likely to be ~2.7-2.8% Q-o-Q, which would be largely volume driven. Cross currency 28900.0 headwinds are likely to impact the revenues to the extent of 20-30 bps for the quarter. 23160.0 EBITDA margins are likely to be under pressure due to Lodestone integration costs, onsite wage hikes (w.e.f Jan 2013) and promotions. However, utilisation could improve with the company delaying freshers recruitment to June 2013. This would restrict the fall in EBITDA margins to 50-60 bps Q-o-Q. PAT is expected to decline on Q-o-Q basis on the back of higher taxes, lower operating margin & lower other income. 40.5 Key thing to watch out for in the management commentary would be FY14 annual guidance, next year's campus hiring and large deal wins, outlook on client budgets and pickup in discretionary spending. FY14 USD revenue growth guidance (if given) could be in the range of 10-12%. Q4FY12 Q4FY13E

EPS (Rs.)

41.4

TCS Net Sales Operating Profit PAT (Adjusted)

Q3FY13

EPS (Rs.)

160699.0 132593.0 USD revenues are likely to grow by 3-3.5% Q-o-Q, largely volume driven on decent project wins & improvement in client mining. Pricing is expected to be stable. Cross currency headwinds could impact the revenues to the extent of 40-50 bps. 46540.0 39145.0 Q-o-Q revenue growth in INR terms is likely to be close to 2.5%. 35518.0 29455.0 EBITDA margin is likely to decline by around 70-80 bps Q-o-Q led by one time provision made for the US$30mn settlement of class action lawsuit in the US (State of California). However, improvement in utilisation levels expected during the quarter is likely to limit the extent of downside in the EBITDA margins. 18.1 15.0 PAT is expected to grow by 1.5-1.7% Q-o-Q due to forex gains expected compared to losses in Q3FY13. Commentary on growth sustainence, view on business ramp ups and pipeline conversion, pricing trends and margin trajectory are key things to watch out. Q3FY13 109487.0 19459.0 17164.0 Q4FY12 98164.0 Q-o-Q USD IT revenue growth could be 1.8-2%, within the range guided by the company (0.5-3% Q-o-Q) with transformational businesses expected to lead the growth. The growth would be largely volume driven and pricing is 16943.0 expected to remain more or less stable. 14809.0

Wipro Net Sales EBIT PAT (Adjusted)

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 EBIT margins are expected to remain stable or improve marginally, as utilisation levels are expected to improve. The USD IT revenue growth guidance for Q1FY14 is expected to be in the range of 1.5-3% Q-o-Q on the back of

EPS (Rs.)

7.0

6.0

anticipated ramp ups in deals closed.

Management commentary on demand environment, deal pipeline & budget trends would be given importance. The

expectations are lowest in Wipro and hence positive surprise is possible. HCLTech Net Sales Operating Profit PAT (Adjusted) EPS (Rs.) Q2JY13 62738 14166 9647 13.9 Q3JY12 52156 USD Revenues are likely to grow by 3-3.5% Q-o-Q, which would be driven by growth in Infra management business and ramp up of large deals signed during the quarter. Some impact on revenues is likely due to cross currency headwinds. 9591 Margins are likely to decline on the back of higher investments in SG&A. Utilisation levels are expected to remain flat. 6026 Lower operating margins could put pressure on PAT. Deal pipeline, outlook on IT service revenues and margin trends and outlook on discretionery spending would be keenly 8.7 watched in the management commentary.

Analyst: Mehernosh Panthaki - FMCG, IT & Midcaps Email ID: mehernosh.panthaki@hdfcsec.com)

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