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Latest IT Sector Update to Make Money in Market

Through this post we will keep updating you about the latest trends in the information technology (IT) sector and will further keep adding the comments below to provide you with the true picture about the sector. So remember to keep reading the comments underneath the post also.

Seasonally soft quarter, further dampened by cross-currency headwinds: Given the furlough and holidays, the December quarter is usually a soft quarter for the sector and this time around it was further affected by cross-currency headwinds, as the Euro, Pound and Australian Dollar has depreciated close to 6%, 5% and 7.8% respectively against US dollar during the quarter.

We expect the reported revenues growth of top four information technology (IT) companies to be in the range of 0.3%-1.1%, though the constant currency growth should be in the range of 2.2%-3.1% quarter on quarter (QoQ). Tata Consultancy Services (TCS) will continue to lead the pack with 3.1% quarter-on-quarter (Q-o-Q) growth (including the Mitsubishi joint venture), however on organic basis HCL Technologies will deliver the highest growth among the top four to around 2.9% Q-o-Q growth, followed by Infosys with 2.7% and Wipro with 2.2% Q-o-Q growth. Among the midcap coverage, Persistent Systems is expected to report 4.7% sequential growth, while Firstscource Solutions Ltd (FSL) to deliver 0.9% Q-o-Q fall.

Stable margins trend: For the quarter, despite the rupee tailwinds, we do not expect any material gain on the margins front. For Q3FY2015, TCS is likely to report 14-basis points (BPS) improvement in earnings before interest and tax (EBIT) margins as compared with 52BPS for Infosys. For Wipro, the adjusted EBIT margins for IT services is expected to remain stable on a Q-o-Q basis at 21.5% against 21.4% in Q2FY2015, while HCL Technologies' staggered wage hike will affect the margins; however, the operational efficiency and currency gain will keep the margins broadly stable, we expect the margins to decline by 31BPS QoQ. In our midcap coverage, Persistent Systems and FSL is expected to deliver margins improvement of 173BPS and 10BPS QoQ, respectively.

Key issues to watch out for would be:

(1) Focus on the management's commentary on the IT budget for CY2015 and the overall demand commentary.
(2) Outlook on energy and utilities, and manufacturing verticals owing to a steep fall in crude oil prices.
(3) Outlook on reinvesting currency gains into the business, given the recent depreciation of rupee.
(4) Hedging policy, given the volatile movement in cross currencies.

Valuation: In the last one month CNX IT has corrected close to 6% owing to the fear of growth tapering off in FY2016 and negative impact of cross-currency headwinds. We believe, FY2016 will see an overall improvement in demand environment driven by the improvement in the US geography, though it could fall short of earlier expectations, but still will be better than FY2015E.

The recent underperformance of IT stocks has already priced in the negatives and offers an opportunity to buy for a decent return in the next 12 months. Our order of stock preference in tier I will be Infosys, TCS, and Tech Mahindra (unrated) and in the midcap space, we like Persistent Systems and FSL.

Check Auto sector update and tyre industry update here.

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