Q3FY19 Quarterly Preview IT Services

Transcription

1 Q3FY19 Quarterly Preview IT Services Head of Equities: Amit Khurana, CFA Associate: Vinesh Vala Tel: Tel: January 04, 2019

2 January 04,

3 Quarterly Preview IT Services - Q3FY19 Result Preview Seasonally weak quarter led by furloughs and holidays We expect Q3FY19 to be a seasonally weak quarter for all Indian IT vendors, due to lower working days and furloughs. There should be a marginal improvement in operating margin for IT vendors, given the positive impact of 2.7% QoQ depreciation of the rupee against the USD. However, lower working days, a reduction in utilization, and rise in investments for digital transformation are likely to affect margins. We believe large Indian IT vendors are likely to report USD revenue growth in the range of 1% to +2.5% QoQ. Tech Mahindra (TECM) and HCL Technologies (HCLT) are likely to lead the USD revenue growth trajectory, while Wipro (WPRO) will lag peers. We expect earnings to rise 8.7%/4.6%/ 4.2%/ 3.6%/ 1.5% QoQ for Tech Mahindra (TECM), Tata Consultancy Service (TCS) / HCL Technologies (HCLT)/ Wipro (WPRO)/ Infosys (INFY), respectively. Among the midcap IT universe, we expect Persistent to report robust USD revenue growth of 5% QoQ since Q2FY19 was low base on account of one project closure while NIIT Tech would report muted USD revenue growth of 1% QoQ due to high base of Q2FY19 on back of ramp up in Insurance & Travel vertical. We are waiting for management expectations on demand conditions, growth in digital, deal inflow, and adoption of digital services across verticals. Tech Mahindra is slated to share its outlook on the telecom & enterprise business and HCLT about the seven product acquired from IBM and IMS business. Negative impact of cross currency to dent revenue growth The USD appreciation against all major global currencies (EURO by 2.5%, GBP 1.8% and AUD 1.8%) will have a negative impact of 50-70bps on USD revenue of Indian IT companies. We believe the 2.7% QoQ weakening of rupee against the USD will increase rupee revenue growth and improve margin by 40-60bps for our coverage universe in Q3FY19. Lower utilization and working days barrier to margin We expect a marginal improvement in the EBIT margin of most of the Indian IT vendors, on account of rupee depreciation and absence of visa cost. We believe headwinds explained above, such as fewer working days, cross currency impact, lower utilization, localization, and investment in digital will restrict margin improvement in the quarter. Higher investments for developing digital capabilities and investment in Sales & Marketing are likely to affect margin in all Indian IT vendors in the short to medium term. Among large cap companies, positive impact on EBIT margin due to the rupee depreciation and operational efficiencies are as follows: WPRO (+44bps), TECHM (+26bps), TCS (+19bps) and HCLT (+11bps). We expect INFY to report decline of 19bps in its EBIT margin during the quarter due to higher investment in enhancing digital capabilities. The EBIT margin of all the midtier IT companies, except KPIT (-18bps QoQ due to decline IES business) and Mphasis (-62bps QoQ due to wage hike impact), are expected to improve marginally in the range of 12-28bps QoQ. INFY and HCLT likely to maintain revenue guidance for FY19 We expect INFY to maintain its constant currency (CC terms) revenue growth guidance of 6%-8% YoY for FY19. However, this will be below the NASSCOM s guidance of 7-9% YoY for the Indian IT sector. HCL Technologies is likely to maintain its revenue growth guidance of 9.5%-11.5% YoY in CC terms for FY19. We believe WPRO will offer a guidance of 1.5%-2.5% QoQ for Q4FY19. January 04, 2019

4 HCLT INFY KPIT MTCL MPHL NIITEC PSYS TCS TECHM WPRO ZENT HCLT INFY KPIT MTCL MPHL NIITEC PSYS TCS TECHM WPRO ZENT View Although, many Indian IT sector stocks have corrected in Q3FY19, we believe that a strong demand trend, due to corporate digital transformation and robust deal inflow will further accelerate the pace of growth in the short term. We remain optimistic about the overall IT sector. However, headwinds persist in the form of INR appreciation and global economic slowdown, especially trade war and Brexit induced, which may lead to a downgrade in the future. Among the large caps, we prefer HCLT as the strategy of Mode 1, Mode2, and Mode 3 offerings is being implemented in line with the company s expectation, and TECHM, as its communication vertical has recovered and deal inflow is healthy. We also like INFY, due to strong visibility in order inflow and road map over next three years. Our stance on TCS is neutral, due to fair valuations. Among the mid-caps, we prefer Persistent (PSYS), as we believe traction in Alliance business and also better growth visibility in Healthcare & BFSI vertical will further aid profitability, and Mindtree (MTCL), as higher exposure in digital services is likely to improve revenue growth. INR Revenue QoQ Growth (%) in Q3FY19E EBIT QoQ Growth (%) in Q3FY19E January 04,

5 Quarterly performance Large caps (` mn) Q3FY19E Q2FY19 Q3FY18 QoQ YoY Comments Infosys Sales (US$ mn) 2,965 2,921 2, US$ revenue growth of 1.5% QoQ Sales 213, , , INR revenue growth of 3.7% QoQ EBIT 50,179 48,793 42, Margin to decline 19bps QoQ PAT 41,599 40,966 37, Cross currency headwind 50bps EPS EBIT margin (%) (19 bps) (66 bps) TCS Sales (US$ mn) 5,298 5,215 4, US$ revenue growth of 1.6% QoQ Sales 381, , , INR revenue growth of 3.5% QoQ EBIT 101,886 97,710 77, Healthy Deal Inflow PAT 82,677 79,010 65, Margin to improve 19bps QoQ EPS Cross currency headwind 70bps EBIT margin (%) bps 152 bps Wipro Sales (US$ mn) - IT services 2,061 2,041 2, US$ revenue growth of 1% QoQ Sales (Including IT products) 149, , , INR revenue growth of 2.5% QoQ EBIT 20,270 19,130 19, Margin improvement by 44bps PAT 19,568 18,889 19, EPS EBIT margin (%) bps (78 bps) HCL Tech Sales (US$ mn) 2,145 2,099 1, US$ revenue growth of 2.2% QoQ Sales 154, , , Recovery in IMS business EBIT 30,899 29,552 25, Mode 3 business to aid growth PAT 26,297 25,247 21, Inorganic growth of 1% from H&D EPS Margin to improve by 11bps EBIT margin (%) bps 42 bps Tech Mahindra Sales (US$ mn) 1,248 1,218 1, US$ revenue growth of 2.5% QoQ Sales 89,913 86,298 77, Better deals in telecom EBIT 14,026 13,242 9, Enterprise to grow on back of HCI PAT 11,572 10,643 9, Adj. EPS (4.8) 23.3 EBIT margin (%) bps 287 bps OFSS Sales 12,756 12,133 10, Healthy License fee revenue EBIT 5,102 4,863 4, Margins to improve 168bps YoY PAT 3,642 3,520 2, EPS EBIT margin (%) (8 bps) 168 bps January 04,

6 Quarterly performance Mid caps (` mn) Q3FY19E Q2FY19 Q3FY18 QoQ YoY Comments NIIT Technologies Sales (US$ mn) US$ revenue growth of 1% QoQ Sales 9,609 9,074 7, INR revenue growth of 5.9% QoQ EBIT 1,393 1, Margins to remain flat QoQ PAT 1,211 1, EPS EBIT margin (%) bps 148 bps KPIT Sales (US$ mn) US$ revenue growth of 0.5% QoQ Sales 11,038 10,789 9, INR revenue growth of 2.3% QoQ EBIT 1,104 1, IES & SAP to decline in Q3 PAT EPS EBIT margin (%) (18 bps) 225 bps Mindtree Sales (US$ mn) US$ revenue growth of 2% QoQ Sales 18, , INR revenue growth of 2.9% QoQ EBIT 2,385 2,296 1, Margins to improve 12bps QoQ PAT 2,043 2,063 1,415 (1.0) 44.4 EPS (1.0) 45.0 EBIT margin (%) bps 119 bps Mphasis Sales (US$ mn) US$ revenue growth of 1.5% QoQ Sales 20,176 19,149 16, INR revenue growth of 5.4% QoQ EBIT 3,188 3,145 2, Wage hike to dent margins PAT 2,714 2,709 2, EPS EBIT margin (%) (62 bps) 35 bps Persistent Sales (US$ mn) US$ revenue decline of 5% QoQ Sales 8,938 8,356 7, Last Qtr impacted by project close EBIT 1, PAT EPS EBIT margin (%) bps 29 bps Zensar Sales (US$ mn) US$ revenue growth of 2.5% QoQ Sales 10,187 9,687 7, Better growth in Digital App Serv. EBIT 1,070 1, Margins to improve 14bps PAT EPS EBIT margin (%) bps (76 bps) January 04,

7 Currency Movement USD/INR Exhibit 6: EUR/USD % 4% 2% 0% -2% -4% -6% % 8% 4% 0% -4% -8% Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 Q1FY19 Q2FY19 Q3FY19 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 Q1FY19 Q2FY19 Q3FY19 Average Rate - LHS QoQ Growth(%) - RHS Average Rate - LHS QoQ Growth(%) - RHS Exhibit 7: GBP/USD Exhibit 8: AUD/USD 1.5 8% % 1.4 4% % 2% 1.3 0% 0% 1.2-4% % -4% 1.1-8% % Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 Q1FY19 Q2FY19 Q3FY19 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 Q1FY19 Q2FY19 Q3FY19 Average Rate - LHS QoQ Growth(%) - RHS Average Rate - LHS QoQ Growth(%) - RHS January 04,

8 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Stock price performance Large caps (x) Stock price performance Mid-caps (x) Infosys TCS Wipro HCL Tech Tech Mahindra NSE IT 50 NIIT Tech KPIT Mphasis PSYS ZENT Mindtree NSE IT January 04,

9 Financials and Valuations Mcap (` bn) CMP (`) TP (`) Upside (%) Reco. January 04, Net Sales (` mn) CAGR % EBIT Margin (%) EPS (`) CAGR % FY18 FY19E FY20E FY21E FY18-21E FY18 FY19E FY20E FY21E FY18 FY19E FY20E FY21E FY18-21E HCL Tech 1, , Buy 505, , , , Infosys 1, Buy 705, , ,790 1,066, KPIT Tech Buy 36,656 43,422 49,314 55, Mindtree , Accumulate 54,628 70,704 81,547 92, Mphasis , Accumulate 65,459 77,405 88, , NIIT Tech 70 1,129 1, Buy 29,914 36,986 44,002 49, OFSS 308 3,609 4, Accumulate 45,275 52,255 57,458 62, Persistent Buy 30,337 35,825 39,484 44, TCS 7,129 1,901 2,050 8 Reduce 1,231,040 1,450,969 1,647,198 1,887, Tech Mah Buy 307, , , , WIPRO 1, (3) Reduce 544, , , , Zensar Tech Accumulate 31,077 37,758 44,119 51, Mcap (` bn) CMP (`) TP (`) Upside (%) Reco. P/E (x) ROE (%) EV/EBITDA (x) FY18 FY19E FY20E FY21E FY18 FY19E FY20E FY21E FY18 FY19E FY20E FY21E HCL Tech 1, , Buy Infosys 1, Buy KPIT Tech Buy Mindtree , Accumulate Mphasis , Accumulate NIIT Tech 70 1,129 1, Buy OFSS 308 3,609 4, Accumulate Persistent Buy TCS 7,129 1,901 2,050 8 Reduce Tech Mah Buy WIPRO 1, (3) Reduce Zensar Tech Accumulate CMP as on 3 rd Jan 2018

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11 DART RATING MATRIX Total Return Expectation (12 Months) Buy > 20% Accumulate 10 to 20% Reduce 0 to 10% Sell < 0% DART Team Purvag Shah Managing Director purvag@dolatcapital.com Amit Khurana, CFA Head of Equities amit@dolatcapital.com CONTACT DETAILS Equity Sales Designation Direct Lines Dinesh Bajaj VP - Equity Sales dineshb@dolatcapital.com Kartik Sadagopan VP - Equity Sales kartiks@dolatcapital.com Kapil Yadav VP - Equity Sales kapil@dolatcapital.com Equity Trading Designation P. Sridhar SVP and Head of Sales Trading sridhar@dolatcapital.com Chandrakant Ware VP - Sales Trading chandrakant@dolatcapital.com Shirish Thakkar VP - Head Domestic Derivatives Sales Trading shirisht@dolatcapital.com Kartik Mehta Asia Head Derivatives kartikm@dolatcapital.com Bhavin Mehta VP - Derivatives Strategist bhavinm@dolatcapital.com Hardik Mehta Sales Trader hardikm@dolatcapital.com Dolat Capital Market Private Limited. Sunshine Tower, 28th Floor, Senapati Bapat Marg, Dadar (West), Mumbai

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