Mr. Amit Chandra, Institutional Research Analyst, HDFC Securities and Mr. Vinesh Vala, Institutional Research Analyst, HDFC Securities

The IT sector (coverage universe) is set to post yet another quarter of strong sequential growth, following the decade best Q1FY22. The growth outlook remains robust, based on (1) strong deal momentum (both pipeline and large deal bookings), (2) broad-based adoption of digital transformation/shift to cloud, (3) positive cyclical indicators in product development/engineering services and consulting, (4) accelerated hiring, and (5) improving alignment/investment in the hyperscalers/SaaS ecosystem. Tier-1 IT is expected to deliver 4.1% QoQ (4.9% CC terms) and 18.2% YoY (despite high base). In comparison, mid-tier IT is expected to post 5.5% QoQ (range of +2.3% to +10.5% QoQ) with larger mid-tier averaging >5.5% QoQ. The margin during the quarter is expected to be negatively impacted by wage hike, higher retention cost, and peaking utilisation, which would be partially offset by operational efficiencies.

Deal wins (TCS – Royal London, John Wiley, Converge ICT, Dutch Golf, Neptune, Rich Products, Standard Bank, Avianca, TFL, NXP; INFY – Select Portfolio, UBP, UCAS, MPI, Forst Bank; HCLT – Fiskars, Roger, Wacker, Munich Re, MKS, Lendico) continued to remain strong in Q2FY22. Acquisition remains a key focus area (TECHM – AustinGiS; MPHL – Blink; PSYS – Software Corp and Shree Partners; CYL -Workforce Delta; SSOF – Encore) for augmenting capabilities in the digital transformation journey. We believe the elevated supply side pressure (rising attrition, retention cost) is transient in nature and will continue for 1-2 quarters, and larger caps may be able to manage it better vs. midcaps.

• Revenue outperformance, led by INFY, WPRO, ZENT, MTCL and PSYS: In Q2FY22E, we expect INFY to lead the growth with 5% QoQ in USD terms, supported by ramp-up of large deals (Daimler), followed by Wipro with 5.5% QoQ growth (~3% organic), led by BFSI (Capco acquisition). TCS/HCLT/TECHM are expected to post +3.6/3.1/3.7% USD revenue growth. Within mid-tiers, ZENT/MTCL/PSYS would lead growth at +9.5/8.5/6.6% QoQ (USD terms). LTI, MPHL and LTTS are expected to post 4.5%, 4% and 3.8% QoQ growth. SSOF is expected to grow by 10.5% QoQ (~4.5% organic), supported by a strong Microsoft portfolio and CYL is expected to report growth of 3.9% QoQ, helped by recovery in services business. Margins during the quarter are expected to be impacted by wage hike and retention cost.
• Key monitorables: (1) Revenue guidance: INFY (expected to increase by ~100bps), HCLT can guide for low teens (vs. guidance of > 10% CC) and WPRO (+2-4% QoQ for Q3); (2) large deal pipeline/bookings; (3) supply side situation, hiring intensity and WFH status; (4) demand environment for cloud/digital led services and outlook.
• Maintain positive outlook: We roll over valuations to Dec-23E and raise target multiples for most of the companies in our coverage universe (except WPRO, TECHM, MPHL and ZENT) to reflect higher visibility/longevity of growth. We expect the sector (coverage universe) to post 13.4% and 14.2% USD revenue/APAT CAGR over FY21-24E, compared to 6.5/7.5% over the past five years. The mid-tier valuation is at ~35% premium (vs. average 15Y discount of ~25%) to Tier-1, driven by strong business momentum, while risk-reward is favorable for tier-1 IT. Our preferred picks are Infosys, HCL Tech, Mphasis, and Cyient.