Q4 Results Preview: IT Services rating
The fourth quarter would be relatively weak in line with seasonal trends,but...
We expect TCS to once again lead revenue growth (QoQ) in a seasonally weak March quarter (Mar-11) in which revenue growth (QoQ) is likely to be 4-6%. On the margin front,with the exception of HCL Technologies,margins for the larger-cap companies could soften in this quarter—a reflection of hiring in preparation of FY12. Notably,for TCS,the QoQ Ebit (earnings before interest and taxes) margin decline is on account of robust hiring (reflecting in lower utilisation QoQ). We expect HCL to show modest margin improvement from Dec-10 quarter levels of 12.5% (including employee stock option costs). HCL is also likely to reiterate its intent to take its June-11 Ebit margins (Q4FY11) to the levels in June-10 (Q4FY10),which implies a 220 bps improvement from current levels. Ebit margins for Infosys could be broadly flattish QoQ.
Now,the focus is more on FY12 and on how well Indian IT companies can capitalise on the solid demand environment. this context,Infosys’ FY12 revenue growth guidance assumes importance —we expect 18-20% revenue growth guidance from Infosys. The company’s guidance could be about R139-141 adjusted for the stronger rupee as of March 31,2011 (as against our earlier expectation of R140-142.) Infosys FY12 guidance on margins could be for 100-150 bps YoY decline (at Q4FY11 pricing assumption for FY12). The company will likely do better on margins with improved pricing and growth over FY12. A positive commentary on pricing likely.
The commentary on wage hikes should indicate same wage inflation in FY12 as in FY11. expect wage inflation (offshore) in FY12 for the large-caps to be around 10-13% offshore and 3-4% onsite. This is likely to impact margins of top-tiers such as TCS/Infosys by 300-350 bps,which gets offset by other factors (improved pricing,pyramid,leverage of growth,non-linearity). The squeeze on the IT mid-cap on account of wage inflation is likely to be much more severe for the same quantum of pay hike (it has to do with the cost structure and margin profile of mid-caps).
The commentary of Wipro will be notable. We await updates from the new management at the time of their first quarterly call on (i) the revamped management structure and (ii) the company’s altered go-to-market strategy. Management’s articulation of how this will deliver going forward is of interest. Firms have incurred a little over $1 m in dealing with the Japan tragedy towards evacuation. This should not impact margins for the larger companies given their base. Wipro has incurred expenses associated with the separation fees of its ex-co-CEOs (about $3.5-4 m) with the possibility of other expenses towards restructuring. This could mildly impact Wipro’s margins.
As FY13 gets factored towards the end of CY11,we believe that front-line stocks can still return about 10-15% over the next 9-12 months. We retain our Overweight ratings on TCS,Wipro and HCL,with TCS and Wipro being our key picks. Our preference for large caps remains.
—JP Morgan
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