Sector Update > Q4FY2016 earnings preview

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1 IT sector update Sector Update > FY2016 earnings preview Soft quarter, cross-currency headwinds add to woes Visit us at April 06, 2016 FY2016 result expectations Soft quarter, affected by cross-currency headwinds: Seasonal weakness coupled with cross-currency headwinds (largely attributed to 5.5% depreciation of GBP against USD) will affect the earnings performance for the March quarter. For the quarter under review, we expect a constant-currency (CC) growth in the range of %. The growth will be led by HCL Technologies (HCL Tech; 2.8%), followed by Infosys (2.5%), Tata Consultancy Services (TCS; 2.1%), Wipro (2.9% [including inorganic Cellant AG]; organic growth at 1.6%) and Tech Mahindra (1.4%). On a reported basis growth will be in the range of %. On the margins front, aided by favourable rupee movement (2.2%) and absence of cost related to Chennai flood in Q3FY2016, will result in positive margins expansion. Key issues to watch out for would be: (1) management s commentary on CY2016 annual IT budget closure and demand visibility in FY2017E; (2) commentary on digital space, specifically deal wins and outlook (Nasscom has estimated 1.5x growth in the digital space for FY2017 [18% Y-o-Y growth]); (3) commentary on the troubled verticals like energy and utilities and telecommunications; (4) commentary on margins and pricing, given that the legacy services are under pricing pressure; and (5) Infosys is likely to guide for 11-13% Y-o-Y growth for FY2017 (higher than the Nasscom estimate of 10-12%). Outlook After a weak and low base of Q3FY2016, growth is expected to be better in FY2016 as per earlier expectations. However, cross-currency headwinds will affect the reported numbers. Nasscom has guided for 10-12% cross-currency growth for FY2017, which was broadly in line with our current estimates for top five IT companies. Overall, we expect that the overall growth should pick up in the coming years with higher incremental spending in the digital space coupled with stabilisation in growth deceleration in insurance and energy space. We believe that the improvement in wins rate coupled with traction in digital technologies will provide momentum in the overall revenue growth in FY E. Nevertheless, we maintain our thesis of industry transition phase, that it is building and adding capabilities for newer technologies in the digital space and renewing the execution process and operations in the traditional services space (which is gradually getting commoditised). This transition phase is going to take some time (may be two to three years) and would result in volatility in the earnings performance in the near to medium term. Valuation We remain selective in the sector and expect the demand environment to gradually pick up in FY2017 and FY2018. We continue to have a constructive view on the IT sector for an investment horizon of 12 months. Preferred picks this earnings season: Infosys, Tata Consultancy Services, HCL Tech (in the large-cap space) and Persistent Systems (in the mid-cap space). Earnings expectations Particulars Sales (Rs cr) OPM Net profit (Rs cr) sector update 1 April 06, 2016 (BPS) (BPS) Infosys 16,597 13, ,592 3, TCS 28,430 24, (35) 51 6,284 5, Wipro 13,404 12, (40) 149 2,391 2, HCL Tech* 10,815 9, ,000 1, Tech Mahindra 6,904 6, (79) Persistent (210) (65) Systems FSL (7) *June year ending

2 Valuations Company Reco Price target (Rs) CMP (Rs) EPS (Rs) P/E (x) FY17E FY18E FY17E FY18E Infosys Buy 1,430 1, TCS Buy 2,750 2, Wipro Hold HCL Technologies* Buy Tech Mahindra Neutral NA Persistent Systems Buy Firstsource Solutions Buy *June year ending FY2016 Infosys Revenues in USD 2, , , Revenues in INR 16, , , EBITDA 4, , , EBIT 4, , , Net profit 3, , , EPS (Rs) EBITDA margin EBIT margin (3) 79 NPM (145) (15) We expect a 2.2% quarter-on-quarter (Q-o-Q) growth in revenues and 2.5% on a CC basis. The crosscurrency headwinds would have a negative effect of ~25 basis points (BPS) on dollar revenues. We expect its earnings before interest, tax, depreciation and amortisation (EBITDA) margins to improve by 77BPS aided by rupee tailwinds. Key monitorables: (1) Revenue growth outlook for FY2017, expect to guide for 11-13% growth; (2) Large deal wins (the company has signed a total contract value (TCV) of $350 million in Q3FY2016 and stated at strong deal pipeline of $3 billion; (3) Pricing and margin commentary; (4) Digital strategy; (5) Progress in automation; and (6) Demand environment in the banking, financial services and insurance (BFSI) space. TCS Revenues in USD 4, , , Revenues in INR 28, , , EBITDA 8, , , EBIT 7, , , Net profit 6, , , EPS EBITDA margin (35) 51 EBIT margin (9) 53 NPM (228) (22) We expect a 1.6% Q-o-Q growth in revenues and 2.1% on a CC basis. Its EBITDA margin is expected to improve by 51BPS led by rupee depreciation. Key monitorables: (1) Comment on outlook for FY2017 and clients budget closure; (2) Commentary on digital deal wins and growth; and (3) Outlook on energy and insurance (Diligenta) segments and geographies like Japan, Latin America and India (management stated at Diligenta expected to bottom out in FY2016). sector update 2 April 06, 2016

3 Wipro IT services revenues in USD 1, , , IT services revenues in INR 12, , , EBITDA IT services 3, , , EBIT IT services 2, , , Total revenues (blended) 13, , , EBITDA (blended) 2, , , EBIT (blended) 2, , , Net profit 2, , , EPS (Rs) EBITDA margin (114) 60 (IT services) EBITDA margin (40) 149 (blended) EBIT margin IT (123) 65 services EBIT margin (55) 158 (Blended) NPM (88) 46 We expect a 2.4% Q-o-Q growth in revenues and 2.9% on a CC basis (closer to the mid level of the guidance revenue growth of 2-4% ). On organic basis, we expect 1.6% Q-o-Q growth and 1.3% from Cellant AG acquisition. Its IT services EBITDA margins are expected to improve by 60BPS to 23.8%, owing to rupee tailwinds. Key monitorables: (1) Revenue growth outlook for Q1FY2017, expect 1-3% sequential growth on organic basis and including inorganic (Cellent AG, Viteos and HealthPlan Services), the guidance will be around % for Q1FY2017 (2) Outlook on margins; (3) Progress on top three priorities (Abid Ali Neemuchwala [CEO] mentioned in the previous conference call); (4) Vendor consolidation deal wins in the energy space and new large deal wins; and (5) Integration of acquisitions of Viteos and Cellent AG. HCL Technologies Revenues in USD 1, , , Revenues in INR 10, , , EBITDA 2, , , EBIT 2, , , Net profit* 1, , , EPS EBITDA margin EBIT margin (10) 121 NPM (8) *Net income for Q2FY2016 includes one-time gain from property sale of $21 million We expect a 2.3% Q-o-Q growth in revenues and 2.8% on a CC basis. The cross-currency headwinds would have an effect of -54BPS. Its EBITDA margins to improve by 118BPS to 22.7%, on account of favourable rupee. Key monitorables: (1) Outlook for FY2017 (the effect of Volvo deal [will consolidate from FY2016] as well as Geometric acquisition in coming quarters); (2) Margin guidance for medium-to-long term; (3) Commentary on vendor consolidation and outlook on IMS revenues will be keenly watched; (4) Investments in digital space; and (5) TCV of deal wins during the quarter. sector update 3 April 06, 2016

4 Tech Mahindra Revenues in USD 1, , Revenues in INR 6, , , EBITDA 1, , EBIT 1, , Net profit EPS EBITDA margin (79) EBIT margin (80) NPM (29) We expect a 0.8% Q-o-Q growth in revenues and 1.4% on a CC basis (weakness in LCC revenues). The crosscurrency headwinds could have an effect of -44BPS. Its EBITDA margins are expected decline by 79BPS on account of wage hike during the quarter which would be partially negated by rupee depreciation. Key monitorables: (1) Growth outlook for FY2017; (2) TCV of deal wins and deal pipeline in telecom space; (3) Margin trajectory; (4) Investments in automation and digital space; and (5) Demand environment in IMS vertical. Persistent Systems Revenues in USD Revenues in INR EBITDA EBIT Net profit EPS EBITDA margin (210) (65) EBIT margin (173) (69) NPM (272) (51) We expect a 4.8% Q-o-Q growth in revenues led by both IT services and IP spaces. Its EBITDA margins are expected to remain under pressure, down by 65BPS on account of investments in IBM alliance coupled with integration related expenses. Key monitorables: (1) Outlook on IP-led revenues would be watched out; (2) Commentary on IBM Watson IoT platform partnership and levers to defend operating margins; and (3) Spending on digital technology. Firstsource Solutions Revenues in USD Revenues in INR EBITDA EBIT Net profit EPS EBITDA margin (7) 81 EBIT margin NPM We expect a 1.7% Q-o-Q growth (4.9% on CC basis) in revenues on account of a ramp-up of recent deals and low base effect. However, still lower than % growth guidance given in Q3FY2016, attributed to large telco clients ramp-down and US healthcare enrollment lower than expectations. Its EBITDA margin to improve by 81BPS aided by rupee tailwinds. Key monitorables: (1) New deal and clients wins/rampups; (2) Order pipeline; (3) Margin and revenue outlook; expect to be lower than the earlier target of $550 million in FY2017. (4) Status on ISGN Corporation integration process and its effect on revenues as well as margins in FY2017. Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article. sector update 4 April 06, 2016

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