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IT firms expected to deliver strong Q3 earnings; slowdown in US could be a risk

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Indian software companies, which will kick off Q3 earnings season later this week, are expected to continue to do well in December quarter driven by consistent growth in US business and BFSI segment, and rupee depreciation, brokerage houses said.

But the only risk, they see, is any slowdown in the US economy going ahead.

According to brokers, the range for revenue growth in constant currency (CC) could be around 1-5 percent along with cross-currency headwinds, largely aided by big deal wins.

“Despite seasonal weakness due to furloughs in Q3, we expect the top 5 Indian IT largecaps to register healthy USD sales growth of 1.5-4.8 percent QoQ in CC (with Infosys at the lower end and HCL Technologiesat the upper end) with cross-currency headwinds of 50-80bp,” CIMB said.

The research house expects robust growth in financial services (BFSI) across most companies. “Increasingly, the ramp-up in large deal wins for most companies should help boost growth.”

Edelweiss also agreed and said as seen in previous quarters, robust growth in digital and large transformational deal wins should accelerate revenue and lead to positive management commentaries.

In a seasonally weak Q3 attributable to furloughs and holiday season, the research house expects the top-5 IT players—Tata Consultancy Services, Infosys, Wipro, HCL Technologies and Tech Mahindra—to clock 2–3.3 percent QoQ revenue growth in constant currency.

Depreciation of major global currencies against the USD is likely to hurt revenue growth again by 40–70bps QoQ, but at the same time, the INR’s depreciation against the USD would lift margins 40–60bps QoQ, it said.

The rupee fell nearly 10 percent against the US dollar in 2018 as the dollar appreciated by 1.3 percent against pound and 1.9 percent versus euro in Q3.

On the operational front, margin expansion is expected to continue in December quarter on rupee depreciation and operational efficiencies, and as a major portion of the cost increase was already witnessed in the first half of FY19.

CIMB expects the top 5 Indian IT companies (except Infosys) to report a 10-30bp QoQ rise in adjusted EBIT margins, led by marginal currency benefits, ramp-up of deal wins and ongoing operational efficiencies.

With increasing supply-side issues in onsite locations, management’s views on margin outlook in near-medium term will be a key thing to watch, it said.

Edelweiss expects the maximum margin expansion sequentially for the quarter.

The broker expects margins at the top-five IT companies to expand 70–100bps driven by INR depreciation and operational efficiencies.

“During Q3FY19, the INR on average depreciated 2.7 percent against the USD, which should increase margin by 40–60bps for the quarter. Headwinds such as visa costs and wage hike are behind now. However, the impact will be limited due to lower utilisation owing to furloughs, investments in digital and localisation, and training of freshly inducted employees,” it said.

In the case of Infosys’ full-year revenue guidance, most brokerages expect Infosys to maintain its guidance, but CIMB and Motilal Oswal expect the IT firm to revise up its lower-end of USD sales growth guidance to around 7-8 percent, from 6-8 percent in CC terms, with its increasing order book. However, Edelweiss, Jefferies, PhillipCapital and Nirmal Bang expect the company to retain FY19 revenue guidance.

For HCL Technologies, brokers do not expect any changes in its USD sales growth guidance of 9.5-11.5 percent for FY19 in CC terms. For both companies, they also do not expect any change in their EBIT margin guidance for the full year.

Key things to watch out for would be the commentary on the deal-flow and CY19 IT budgets, commentary surrounding Brexit, US tariffs on Chinese imports, commentary from largecaps on client IT spending, pricing pressure, growth in digital services, BFSI outlook, Europe revenue growth rates, and changes in employee matrix, viz., hiring and attrition.

FY19 guidance by Infosys and HCL Technologies and next quarter guidance by Wipro will also be the key metrics to watch out for.

“Commentary on 2019 outlook will be keenly watched especially given recent concerns over US economy and growth uncertainty indicated by Accenture,” CIMB said.

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