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IT sector Q1FY20 preview: Analysts expect margins to remain under pressure

IT sector Q1FY20 preview: Analysts expect margins to remain under pressure

IT sector Q1FY20 preview: Analysts expect margins to remain under pressure
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By Pranati Deva  Jul 9, 2019 11:22:48 AM IST (Published)

Analysts expect Indian IT companies to report a moderate set of results in Q1FY20 – primarily due to weakness in margins on the back of wage hikes, high attrition, visa costs, and a strong rupee.

Brokerages expect first-quarter earnings for IT services companies to be a mixed bag, however, margins shall decline on the back of a resurgence of the US dollar, wage hikes, high attrition, visa costs and a strong rupee. According to them, tier-I companies such as TCS, Infosys, Tech Mahindra will drive growth in the sector, while midcap IT companies shall be under pressure heading into the quarter.

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"Owing to continued strength in the rupee and possible margin slippage in select companies, we believe there could be margin downgrade in select stocks which can weigh on earnings. We expect midcap IT vendors to show margin pressure owing to continued strength in INR, higher attrition and pent up investments. While the sector has benefited from INR depreciation (9 percent YoY in FY19E), a similar tailwind is unlikely to exist in FY20," said Centrum Broking in a report.
Key monitorables for the sector includes commentary on deal pipeline/conversions, macro situation, growth in digital, margin outlook and impact of supply-side factors such as wages, localisation, visa cost and sub-contracting.
Here's what top brokerages expect from first quarter results of the IT sector:
HDFC Securities
The brokerage believes the IT sector’s growth vector is intact, however, margin headwinds have increased on supply-side factors and currency. Notwithstanding the growth divergence within the sector, they expect 1Q aggregate revenue growth to accelerate (on a YoY basis) to 5-quarter high, but margins slide to 8-quarter low.
Among tier-1, they expect Tech Mahindra and HCL Tech to have bigger operating margin dent sequentially, while TCS and Wipro to outperform on margins. Within tier-2 IT, Mindtree and L&T Infotech are expected to have higher margin impact, they added.
Phillip Capital
With minor changes in global currencies against the dollar, the brokerage expects cross currency impact to be marginal in this quarter. The companies are likely to report constant currency organic revenue growth of -1.1 percent to +3.1 percent QoQ with 20-50 bps negative cross-currency impact. Margins will decline due to the wage hike, visa cost and rupee appreciation, it added.
However, it also expects the deal flow momentum to continue – providing for a bright outlook for the sector.
"Large-cap companies are expected to report decent results with the exception of Tech Mahindra. Midcap companies are expected to perform decent (except Cyient, Persistent Systems), with double-digit YoY growth," it said.
"We have made minor changes to our FY20-21 estimates for all companies (except Mindtree, which we cut our estimates by 4 percent). We maintain our overweight stance on the sector and expect revenue growth to revert to low double digits in FY21 (for large caps). We maintain 'buy' rating on TCS and Wipro. Tech Mahindra remains our only 'sell' amongst the large caps. In the Mid-cap space, we like L&T Technology Services and Cyient," it added.
Centrum
The brokerage expects Tier 1 IT vendors to deliver 3-0.7 percent QoQ constant currency (cc) revenue growth in Q1FY20E. USD revenues could grow/(drop) by 2.5-(1.3) percent QoQ for 1QFY20E.
Wage hikes and H1B visa application expenses would be additional headwinds for 1QFY20E. Hence, they expect Tier 1 IT companies’ EBIT margins to drop 80-220 bps QoQ for Q1FY20E. Infosys and Tech M are rated 'Add' in Tier 1 IT. Midcaps could show margin slippage owing
to strengthening rupee and cost headwind, it further said.
Prabhudas Lilladher
The brokerage expects the first quarter of FY20 to deliver mixed results.
"We expect revenue growth in constant currency (CC) between 0.7-3.2 percent QoQ for tier-1 IT companies. We expect TCS to deliver 3.2 percent QoQ CC broad-based growth across verticals and geographies, while Infosys shall deliver steady growth of 2.5 percent QoQ CC, with 146 bps QoQ decline in margins led by wage hikes, H-1B visa costs, and rupee appreciation," said Prabhudas Lilladher in a report.
They expect tier-I companies to deliver mixed growth, while growth for tier-II companies could be muted. The firm also expects margins to remain under pressure across the pack.
Motilal Oswal
The firm expects revenue to grow 11 percent, while EBITDA and PAT could grow 9 percent and 4 percent respectively, in the first quarter of FY20.
"We expect the EBIT margin across the top-tier to shrink by 50-160 bps, with the contraction particularly pronounced (100bp+) at TCS, Infosys, and Tech Mahindra," said Motilal Oswal in a report.
The firm also said that they would keep an eye on attrition rates this quarter, along with the impact of visa expenses on profitability.
"As attrition rates have been high and visas remain hard to come by, commentary on margins across the board may shape the course for the sector’s FY20 earnings expectations and near-term valuations," it added.
The brokerage prefers Cyient, Infosys, Tech Mahindra, and Zensar Technologies.
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