IT Sector Expected To Post Robust Q3 Earnings

The momentum will be sustained on larger deals on a full-scale digital transformation

IT Sector Expected To Post Robust Q3 Earnings
Yagnesh Kansara - 06 January 2021

The earning season of India Inc for the third quarter is expected to kickstart with the result announcement from Information Technology (IT) giant Tata Consultancy Services (TCS) on Friday, January 8. The IT sector is expected to deliver stellar performance despite COVID-related hindrances it faced during the quarter ended December 31, 2020. Most of the brokerages are bullish about the performance of the IT sector companies that will take the lead in declaring their Q3 result in the coming days. According to the brokerages, the companies that will post better than expected results in the Tier I category of the sector include Infosys Technologies and HCL Technologies while the Tier II category includes companies like Mphasis and Persistent Systems.

In its results preview report HDFC Securities said, the stocks covered by the brokerage under the IT sector, its coverage universe, is set to post its strongest third quarter (3Q) sequential growth of the past eight years, despite the seasonality factor and the volatile macro situation. Following a 6 per cent Quarter-on-Quarter (QoQ) growth (rebound) in revenue in the second quarter (2Q), 3Q is expected to print 3.7 per cent QoQ for the sector. The stage is set for a double-digit return in 2021-22.

Echoing a similar view, Motilal Oswal Financial Services (MOFSL) too said the long-term outlook for the sector remains attractive even though the IT sector trades at a 40 per cent premium to its 10-year average multiple.

MOFSL Institutional desk in its report said the IT sector is expected to sustain double-digit top-line growth in the medium term. This momentum will be sustained based on larger deals on a full-scale digital transformation, tail of projects steered by an increased focus on workplace management, and higher spend on cloud migration by large corporates.

During the bloodbath witnessed in the market post in March 2020 and the recovery seen thereafter, was led by two sectors—Healthcare and IT--. Despite IT sector trading at a considerable premium, “The rally in IT stocks should continue based on a strong QoQ growth (3 per cent on an average) in a seasonally weak quarter”, the MOFSL report said.

HDFC Securities report, ‘IT sector Q3FY21 Preview’, prepared by Apurva Prasad and Amit Chandra, Institutional Research Analyst, said the IT sector will be starting 2021 on a high note. Key drivers for the sectors are accelerated cloud consumption and shift to the cloud (migration and modernisation of workloads) triggered by the pandemic, portfolio consolidation of vendors and applications

by enterprise clients driven by cost optimisation and leading to multiple large re-badging deals, improving partner ecosystem/alliances, and continuity in strong execution, despite operational displacement and re-alignment.

The profitability of the IT companies in 3Q is expected to be flat (-30 basis points (bps) QoQ following +240bps QoQ in 2Q) with wage hikes and large deal cost, impact offset by operating leverage and favourable cross-currency, they said.

Despite the resumption of wage hike and high base in Q2, MOFSL in its report noted, there will be a limited impact of these developments on margins of IT sector companies covered under its universe in 3QFY21. This will be due to higher returns from utilization and positive operating leverage. Sequential earnings before interest and tax (EBIT) margin for TIER I companies like TCS, Infosys, HCL Tech, and Wipro should be stable in the (60) to 40 bps range, while Tier II IT companies may witness contraction in the range of 0-160 bps due to a hike in wages.

The negative impact of the wage hike will be felt more in Q4 when more companies will resort to offering higher salaries to their employees.

For estimated 2020-21 Earnings Per Share (EPS), MOFSL said, “we currently build-in a 5-7 per cent change in our EPS estimates for our coverage universe. Subject to companies’ commentaries, there may be an upside risk to our estimates.”

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