Infosys, Wipro, TCS, HCL Tech Q3FY21 Results Preview: The IT sector (coverage universe) is set to post its strongest Q3 sequential growth of the past eight years, despite the seasonality factor and the volatile macro situation. Following a 6% QoQ growth (rebound) in revenue in 2Q, 3Q is expected to print 3.7% QoQ for the sector. The stage is set for a double-digit FY22.
Key drivers are:
(1) Accelerated cloud consumption and shift to cloud (migration and modernisation of workloads) triggered by the pandemic
(2) Portfolio consolidation of vendors and applications by enterprise clients driven by cost optimisation and leading to multiple large re-badging deals
(3) Improving partner ecosystem/alliances and continuity in strong execution, despite operational displacement and re-alignment
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Profitability in Q3 is expected to be flat (-30bps QoQ following +240bps QoQ in 2Q) with wage hikes (TCS, Wipro, Persistent Systems while others over 4Q and 1Q) and large deal cost, impact offset by operating leverage and favourable cross currency.
Large deal momentum remains strong and deals TCV (Total Contract Value) numbers for Q3 are expected to be robust for TCS (PBS-Deutsche, Prudential, Equinor), Infosys (Daimler, Rolls Royce), Wipro (Metro AG, Fortum), LTI (Injazat), and Mindtree (Nordex). M&A intensity (volume terms) accelerated in 3Q with nine acquisitions. Deal wins in the cyclical ER&D segment (LTTS-Schindler, O&G sector deal, Tata Elxsi-Aesculap AG) also point towards a recovery trajectory. Other positive demand indicators from Accenture’s recent update include continuity in strong deal bookings and outlook of acceleration in its second half of FY21.
Key pointers to monitor:
(1) Commentary on client tech budget for CY21
(2) Progression/regression on large deals, overall deal bookings and deal pipeline
(3) Performance breadth by verticals and outlook on core verticals – BFSI, Retail & CPG
(4) Trends in large deals (closure timelines, profitability) and pricing trends in digital
(5) ER&D (Educational, Research and Dissemination) services outlook by industries
(6) DSO (digital storage oscilloscope) as temporary discounts reverse & capital allocation stance (increased volume of M&A activity in Q3).
Key risks are:
1) Macro recovery upending
2) Unfavourable USD-INR swing.
HDFC Securities roll-forward valuations to Dec-22E, and their preferred picks include Infosys, HCL Tech, Mphasis and Persistent systems.