Technology- Polarisation likely in seasonally strong quarter

While the glory days for IT are far from back, valuations are back to the past ranges for large IT and in a new territory for tier-II IT. The valuations this time around are a combination of: Bottoming of cyclical pressures, greater hopes from Digital, improved capital allocation by multiple companies, and currency’s new zone that drives greater earnings comfort.

Against this backdrop, seasonally strong first quarter pattern needs to be kept intact, and the benefits from currency need to percolate down to operating profits.

CC revenue to continue accelerating

The trend of revenue growth acceleration of the past two quarters across coverage universe of Motilal Oswal on YoY constant currency basis should continue into Q1FY19 as well. However, this should be without material recovery in the troubled large money banks in the US. Strong H2FY18 deal wins across other verticals should drive this growth.

Across top-tier, quarterly performance should be divergent, with sequential revenue decline at Tech Mahindra (seasonality) and Wipro (one-off client bankruptcy and healthcare weakness), but sanguine growth at TCS (3.3 per cent QoQ CC), Infosys (2.3 per cent QoQ CC) and HCLT (3.2 per cent QoQ CC).

Regarding currency swings, as the rupee depreciated, it will be a tailwind for profitability. Cross currency movements are expected to drag top-tier

revenue growth by 120- 150bp. However, despite the tailwind from the rupee, no meaningful margin expansion is expected. This is due to wage hikes at TCS, Infosys, Wipro and Tech Mahindra.

Among tier-II IT, margin expansion is likely to be the sharpest at Zensar Tech followed by Persistent Systems.

Valuation and view

Bottoming cyclical pressures and improved capital allocation are factors that will feed into valuation multiples favorably. Currency keeps earnings growth ticking further. That said, many stocks demonstrating the impact on earnings and increasing payouts already appear expensive.

Source: Motilal Oswal