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IT sector Q1FY21 preview: TCS to kick off earnings season tomorrow; what to watch out for

IT sector Q1FY21 preview: TCS to kick off earnings season tomorrow; what to watch out for

IT sector Q1FY21 preview: TCS to kick off earnings season tomorrow; what to watch out for
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By Ankit Gohel  Jul 8, 2020 5:05:33 PM IST (Updated)

Information technology sector will kickstart the April – June 2020 earnings tomorrow, and Tata Consultancy Services (TCS) is the first company to announce the financial results.

Information technology sector will kickstart the April – June 2020 earnings tomorrow, and Tata Consultancy Services (TCS), India’s largest software services exporter, is the first company to announce the financial results.

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As expected, the Indian IT companies anticipate a washout in terms of revenue because of the macroeconomic instability caused due to the coronavirus-induced lockdown globally.
The IT sector is expected to witness a sharp decline in QoQ growth in Q1FY21 while Q2 would at best stabilise. Analysts believe Q3 and Q4 being seasonally weak, will not be able to breach above FY20 absolute revenues in spite of being stronger than past. However, a huge pent-up demand FY22 onwards is expected led by large scale cloud migration and digital transformation.
"We believe COVID-19 has had a severe impact on the tech sector as well due to supply-side challenges and constraints regarding the execution of regulatory and compliance work. The lockdowns have limited new deal wins and will have a ripple effect on getting substantial growth back till FY21 end," Edelweiss Securities said in a report.
Despite the partial impact of COVID-19 in Q4FY20, deal bookings remained resilient even with net new signings showing a strong increase.
Margins during the quarter are likely to surprise positively as margin disruptions may not be as severe as feared given the relatively lower pricing impact noted by the sector so far.
"While a fall in utilisation levels and negative operating leverage should hurt margins, they should be partly offset by sharp rupee depreciation, the deferral of salary revisions, and the absence of certain general and administrative (G&A) or PM CARES fund related expenses," brokerage Motilal Oswal said.
Overall, while the sequential EBIT margins of tier I companies may contract by 240 – 70 bps, tier II companies may see margin contractions in range of 180 – 50 bps, brokerage said.
Meanwhile, UBS expects the least margin drop for Infosys, while Cognizant is likely to see the most. Further, Q2/H2 FY21 outlook and management commentary will be key triggers.
"Any commentary of the speed and shape of the recovery is likely to be the key mover for share prices and market sentiment in Q1 FY21. Our interactions suggest that investors expect a QoQ acceleration from Q2 FY21 itself; any commentary that supports such a recovery will likely be viewed as a positive, while commentary that suggests limited acceleration would likely be a negative catalyst," UBS said in a report.
The brokerage does not expect companies to provide guidance for FY21/CY20 along with Q1 FY21 earnings.
According to Edelweiss Securities, "TCS is expected to see a revenue decline of 3.5 percent in constant currency (CC) terms impacted by weakening pound and rest of the world (GBP/ROW) currencies against the dollar leading to 4 percent decline QoQ in dollar. Gains from a weak Indian rupee and operational rigour should help TCS contain margin decline to 34 bps versus Q4FY20 despite sharp fall in growth rate. We will be monitoring commentary on the macro environment and new deals and cost control."
Infosys' revenue is expected to decline 3.7 percent QoQ in CC terms (4 percent QoQ in USD terms) on cross-currency headwind, while EBIT margin is likely to contract 23 bps QoQ owing to lower growth, although substantially offset by a depreciating rupee.
HCL Technologies' revenue may fall 6 percent QoQ in CC while margin may decline by 69 bps as gains of weak rupee is expected to be more than offset with sharp decline in utilization level.
Outlook on demand in IMS, primarily the benefit of cloud migration, and the status of IBM's products will be key to watch for, according to Edelweiss Securities.
Wipro is estimated to see a revenue decline of 5.7 percent in CC terms while a 20 bps of cross-currency headwind to arrive at USD decline of 5.9 percent QoQ. The company will also witness margin decline of 110 bps due to sharp fall in growth, not completely offset by currency benefit. The company’s new CEO’s and his strategic direction will be key monitorable.
Further, Edelweiss Securities expects Tech Mahindra to report a sharp 7.5 percent decline in revenue on QoQ basis in cc terms. "The sharp decline in revenue will also have a rub-off effect on margin, largely offset by weakening rupee. We would keep a close watch on 5G capex-related commentary and margin recovery for the future," the brokerage said.
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