The Indian IT service sector is expected to see median revenue growth of 4.2 per cent quarter-on-quarter (QoQ) with earnings before interest and taxes (EBIT) growing at 5.8 per cent as well as profit after tax (PAT) at 6.2 per cent growth in Q3 of FY22 , according to a sectoral report by Motilal Oswal.
This is despite the seasonal adversity for the Indian IT services sector where the third quarter of the financial year is usually weak due to fewer billable days caused by higher holidays around Christmas and New Year.
The report states that tier 2 companies are expected to outgrow tier 1 companies in the upcoming season, with tier 1 companies to deliver revenue growth in the 3.2-4.8 per cent QoQ range, while tier 2 players will have a wider band of 3.6- 7.1 per cent.
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“Despite companies highlighting the normal impact of furloughs, IT revenue growth for tier 1 is expected to be strong, with Infosys leading revenue growth. Companies like Infosys, HCL Technologies, Tech Mahindra and Wipro and TCS are among the tier 1 companies expected to register a revenue growth above 3 per cent,” said Mukul Garg and Raj Prakash Bhanushali, research analysts with Motilal Oswal.
Among tier 2 players, good revenue traction is expected too. Persistent Systems is leading the pack at 8.1 per cent QoQ growth. Larsen & Tourbro Infotech is expected to grow by about 7 per cent QoQ and L&T Technology Services (LTTS) should grow well over 5 per cent in Q3 FY22. .
The earnings before interest and tax (EBIT) margins for most of the companies are expected to be on the narrower side due to pressure from the supply side. Tier 1 companies are expected to see a steep decline compared to the Q3 FY21 profitability. EBIT margins of most of the tier 2 companies are expected to be stable.
Emerging risks
Hiring across the IT sector would remain high as companies try to fulfil demand and backfill growing attrition, which will be a key focus area for investors. The resurgence of COVID-19 cases remains another risk on the supply side.
However, PAT is expected to see a growth of about 11 per cent year-on-year (YoY) and about 6 per cent QoQ.
TCS and Infosys are expected to report a PAT growth of 17 per cent and 13 per cent YoY respectively.
HCL Technologies might see a slight decline in PAT while Wipro will witness the impact of a YoY dip in margins. Tech Mahindra is expected to post about 14 per cent YoY and PAT growth.
Tier 2 players are expected to report a robust PAT growth of about 23 per cent YoY and 6 per cent QoQ, driven by strong revenue growth, which would be partially offset by lower EBIT margins.
Coforge, LTTS, Persistent Systems are expected to lead the tier 2 pack in terms of YoY PAT growth, while the same for Zensar Technologies could be down by double-digits due to an adverse margin base as well as higher investments.
While share valuations remain elevated, the report states a good demand environment and a sustainable double-digit top-line growth in the medium term.
“The demand is expected to remain strong mainly due to the increased deals on a full-scale digital transformation, upward price revisions, and higher spend on Cloud migration by large corporations” the analysts added.
The report analyses continuation of the strong sequential growth momentum and the expectation of a qualitative commentary on growth beyond FY22 should help sustain the rally in IT stocks, despite their premium valuations.
