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| Summary of Contents SECTOR UPDATE Q2FY2015 IT earnings preview Key points - A seasonally strong quarter: For Q2FY2015, seasonally a strong quarter, we expect the top 4 IT services companies to report a healthy sequential growth of 4.5-9.0% in revenues. Taking into account the unfavourable cross-currency movements that shall negate the benefits of a 1.6% Q-o-Q depreciation in the rupee against the dollar, the currency gains shall add little to the revenue growth for the quarter.
- TCS to lead; Wipro remains laggard: Tata Consultancy Services (TCS) continues to lead the pack with a 7.4% Q-o-Q growth in revenues, driven by the consolidation of the Mitsubishi joint venture. On an organic basis, the company would report a growth of 5% QoQ. We expect Infosys and HCL Technologies (HCL) to report a Q-o-Q growth of 3.5% and 3.2%; Wipro may continue to lag the pack with a 1.9% Q-o-Q growth in revenues. In our mid-cap coverage universe, Persistent Systems Ltd (PSL) is expected to lead with a 5.1% Q-o-Q growth while NIIT Technologies (NIIT) may report a decline in revenues sequentially.
- Stable margin trend: TCS and Infosys did not have any wage hike and visa expense during the quarter; thus, both the companies are likely to report an improvement in the margin. TCS is likely to report an improvement of 110 basis points (BPS) in the earnings before interest and tax (EBIT) margin as compared with a 68-BPS improvement for Infosys, led by a lower depreciation cost for the quarter as compared with a one-off higher charge in Q1FY2014. For Wipro and HCL, wage hikes will affect the margins; however, operational efficiency and currency gains will keep the margins broadly stable. In our mid-cap coverage, PSL and Firstsource Solutions Ltd (FSL) are expected to deliver a margin improvement of 161BPS and 44BPS QoQ whereas NIIT's margin is expected to remain stable.
- Key issues to watch out for: (1) Infosys to be in focus, as investors will keenly watch for the commentary and roadmap for the future from the new chief executive officer, Dr Vishal Sikka; (2) commentary on digital technologies from TCS and Infosys; and (3) outlook on re-investment of currency gains into business, given the recent depreciation in the rupee against the dollar.
- Valuation: We maintain our positive stance on the sector, given the broad-based demand recovery and gradual acceptance of digital technologies. We believe that given the strong earnings predictability and return ratios, and impressive cash flows, the IT sector's valuation will continue to attract investor interest. Among the tier-I information technology (IT) companies we like TCS, Infosys, HCL and Wipro in that order while in the mid-cap space we like PSL and FSL.
Q2FY2015 Capital goods & engineering earnings preview Key points - We expect the aggregate revenues of the capital goods companies under our coverage to grow by 5% YoY in Q2FY2015 due to a decline in the revenues of heavyweight BHEL and a moderate revenue growth in case of Finolex Cables and Thermax. However, excluding BHEL the aggregate revenues are expected to grow by 12% YoY supported by a healthy double-digit growth in L&T, Crompton Greaves, V-Guard and KPTL.
- We expect the overall margin to show an improvement as all the companies except Finolex Cables are likely to report a better margin compared with the last year. We could attribute the improvement to the cost-rationalisation efforts undertaken by several companies in the past. Consequently, the net profit of the coverage companies is expected to grow by 12% YoY.
- Currently the book/bill ratio of our coverage companies hovers around 2.7x, which is certainly low compared with the historical level. But during Q2FY2015 we saw some early signs of fresh order flow. Though there has not been any material improvement in the order environment but we believe it could reflect in the next two to three quarters.
- Expectations of an economic revival led by a boost to the investment cycle are largely priced in the price of most of the stocks. Further, the market is waiting for signs of an improvement in the earnings, as an investment-led recovery should translate into better order inflow and consequently earnings expectations. In our view, the next leg of the re-rating should start with an improving earnings visibility, which could come in the next two to three quarters.
| | | Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article. | |
| Regards,
The Sharekhan Research Team |
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