TCS and Infosys are set to kick off the earnings season of Indian IT services companies this week. After a good run through the year so far, the sector is set to face some roadblocks. We look at how it may impact the third-quarter results.

“We expect growth acceleration in Q3, and for all top five IT service providers third-quarter year-on-year (y-o-y) growth should be better than second-quarter y-o-y growth. This is because of large deal wins in the last 12 months across the board, whose benefits will continue to accrue in Q3,” said Pareekh Jain, founder of Pareekh Consulting.

Significant deals made

Despite fears of digitalisation cutting down deal sizes, IT companies in the past year were able to crack some of the largest deals in their history. TCS, for example, bagged three multi-year billion-dollar deals, totalling more than $5 billion in revenue since December 2017. Wipro in September won its largest ever $1.5 billion contract from Illinois-based Alight Solutions LLC, a deal spread over 10 years. HCL Technologies signed a five-year deal with Nokia worth over $500 million.

“Gradually improving y-o-y growth rates, anticipated continuum of the same in Q3, FY19 and a strong order book have all been indicators of secular strength in demand for IT Services. Growth is expected to continue accelerating into 3QFY19 (our estimate: 8.9 per cent y-o-y CC), contributed by good progress at each of the top five clients,” said analysts at brokerage firm Motilal Oswalin a note.

“We expect 11.7 per cent y-o-ygrowth at TCS — the highest among tier-I — while TECHM should lag with 4.7 per cent y-o-y CC growth, given sluggish momentum in Communications. We expect growth at INFO to accelerate to nine per cent y-o-y CC from 8.1 per cent in Q2, FY19,” the note added.

Macro concerns

The trade war between the US and China has already seen Apple lowering its revenue guidance for the year. This should be seen a warning sign for the overall IT services industry as growth slowing in the US will have a heavy impact on Indian IT in the long run.

Analysts are expecting some commentary from the IT services companies on the impact of this likely slowdown in the US, as well as the ramifications of Brexit. The US continues to be the biggest market for the entire Indian IT industry, despite its efforts to expand presence in other geographies.

“In our view, key monitorables for the street from the Q3 results are likely to be digital growth and deal size trends, outlook for key verticals including BFSI, Retail and Telecommunications and CY19 IT budget outlook. Apart from this, deal flows and order book are critical data points to watch out for,” Harit Shah, research analyst at Reliance Securities said.

Reliance Securities expects the IT firms under its coverage universe to post a combined 1.4 per cent quarter on quarter rise in dollar revenue in the third quarter.

The rise of Indian currency could also reflect in the upcoming earnings report from the sector.

Compared to Q2, Rupee appreciated about up to nearly three per cent against major currencies such as the US dollar, Euro, Pound Sterling and Australian dollar in Q3.

“We expect 50-70 bps adverse impact of cross-currency movement in Q3, FY19 for top-tier IT firms, while for mid-tier IT firms, impact is seen at 25-45 bps,” Shah said.

According to Reliance Securities, the top five IT firms are likely to post 0.7-2.1 per cent q-o-q dollar-revenue growth (1.3-2.6 per cent q-o-q in CC terms) with Tech Mahindra likely to lead the pack (2.1 per cent q-o-q dollar growth, 2.6 per cent CC growth). Among mid-sized firms, Persistent Systems is expected to out-perform with 6.6 per cent q-o-q dollar-revenue growth led by IP business seasonality, while Cyient is likely to trail (flattish revenue owing to weak DLM seasonality).

Revenue growth is likely to come in at 2-9 per cent q-o-q, owing to Rupee depreciation, as per Reliance Securities.

On the margin front, Wipro is expected to post 200 bps EBIT margin expansion in its Combined IT Services business led by absence of one-time items and Rupee depreciation.

Other top-tier firms are expected to post largely range-bound margins with some margin gains likely to be reinvested to sustain revenue growth, going forward.