Macro woes, margin pressure to drag IT firms' Q2 earnings

Moneycontrol Bureau

July-September is normally a seasonally strong quarter for software service providers. However, this time around most companies are likely to report muted growth given tighter budget spends amid continued uncertainties in the global macro-economic environment.

Further, with the rupee appreciating during the quarter and the full effect of the wage hikes flowing through for most companies, the margins are expected to be under pressure too.

Analysts expect a revenue growth of 2-5% in US dollar terms for most IT companies, little better than first quarter, but don't expect big surprises.

"We expect limited growth surprises with discretionary demand continuing to be soft and large revenue contributors like banking, financial services and insurance (BFSI) and telecom continuing to be sluggish," said Ashwin Mehta and Pinku Pappan of Nomura Financial Advisory and Securities India.

Yogesh Aggarwal of HSBC Securities and Capital Markets expects 0-4% volume growth and a "modest" 50 basis points fall in pricing.

He too maintains that demand from BFS clients, particularly in the US, has remained weak, although infrastructure management services projects remain abundant as customers look to restructure their IT infrastructure.

Tata Consultancy Services  , India's top IT services provider, and HCL Technologies  are expected to outpace Infosys  and Wipro  .  While TCS, Infosys and HCL Tech are likely to report around 3-5% USD revenue growth, most analysts expect Wipro to be a laggard with around 2% growth.

'We expect management commentary to remain cautious on near-term revenue visibility with delayed ramp-up in large deals and longer decision making cycles. Companies are likely to be optimistic about recovery in calendar 2013 with some improvement in deal awards," said Hitesh Shah and Abhishek Gupta of IDFC Institutional Securities.

MARGIN PRESSURES

While revenue growth is likely to be modest, there is unlikely to be anything to cheer for on the margin front as well. The rupee fell sharply to the US dollar in April-June, but it has appreciated in the current quarter. Furthermore, there will also be the full impact of salary hikes given by several companies. Many IT companies are expected to report a decline in margins, however, TCS and Infosys may see an uptick.

"We estimate EBIT margins of TCS/Infosys to expand by 30/120 bps and decline by 90-250 bps for Wipro IT Services, HCL Tech, Tech Mahindra  , Satyam and Persistent  ," said Shah and Gupta of IDFC.

Citigroup analysts Surendra Goyal and Rishi Iyer don't expect rupee to be a big swing factor in the July-September quarter, but could weigh on margins in the Oct-Dec quarter and beyond, if the rupee appreciation continues.

KEY THINGS TO WATCH

-- Deal wins and commentary on demand scenario
-- Outlook for the second half of the current financial year.
-- Outlook on margins and hiring
-- Pricing trends

WILL INFOSYS CUT EPS GUIDANCE?

Bangalore-based Infosys, once the IT bellwether, had shocked the street when it reported lower-than-expected net profit in the first quarter and also cut its full year USD revenue guidance sharply to just 5% growth from 8-10% it had expected earlier.

A few analysts, like Goyal and Iyer of Citigroup, feel the company could lower its FY13 earnings per share (EPS) guidance due to the rupee rise. Infosys' rupee guidance is now likely to be at Rs 53 per US dollar, compared with Rs 55 per USD at the end of the first quarter, they say.

Infosys has so far not hiked wages this year, and had earlier said it would revisit the decision in October. Now some like the Nomura analysts say "there is a high likelihood of a wage hike in the third quarter as growth comes in line with guidance."

STOCK TALK

IT stocks have underperformed the broader markets since June-end with the CNX IT index rising 4%, compared with the near 10% uptick in the Nifty index.

HSBC Securities and Capital Markets on Thursday, downgraded TCS and HCL Tech to "neutral" from "overweight' on valuations and said IT stocks were likely to remain lackluster through the second quarter results season as discretionary spending had stayed weak.

Citigroup analysts also say TCS' valuations are running high. HCL and Infosys are among their top picks. Nomura advises a "buy" on HCL Tech and Hexaware , rating other Indian IT companies like TCS, Infosys, Tech Mahindra and Wipro "neutral."