IT sector growth momentum set to continue in Q2FY22

• Follow

The Q2FY22 earnings season will commence this week with IT major TCS to announce its results on October 8. Robust demand in a seasonally strong quarter is expected to translate into blockbuster earnings for Indian IT firms. Deal wins and pipelines are poised to see healthy growth in Q2FY22. Motilal Oswal Financial Services expects Tier-I IT companies should deliver revenue growth between 3.9% and 6.9% QoQ CC (constant currency), while Tier-II companies will have a wider growth band (4.9-10.5% QoQ CC).

According to the brokerage firm, Infosys should lead revenue growth in Tier-I IT (+5.7% QoQ CC) on an organic basis, while Wipro should deliver 6.9% QoQ reported growth. This will be followed by TCS (+4.2% QoQ CC), TECHM (+4.2% QoQ CC), and HCLT (3.9% QoQ CC).

Among tier-II IT companies, it expects upbeat revenue traction, with Mindtree leading the pack with 8.5% QoQ CC growth, aided by deal ramp-ups and broad-based growth. Persistent Systems and Mphasis (Direct business) should also deliver strong performance in 2QFY22, with growth above 6% QoQ.

Margins may take a hit

Emkay Global believes EBITM (Earnings Before Interest Tax Margin) is likely to remain under pressure for some companies due to the salary hike cycle, higher subcontracting costs, uptick in attrition, and higher recruitment costs. For some companies, EBITM is likely to be flat or expand, thanks to the normalization of wage hikes and revenue growth led operating leverage.

“Dip in margins for most companies on supply-side pressures (attrition and hiring), along with a wage hike impact (Infosys, Wipro, Persistent Systems, and Zensar Technologies). Among Tier-I IT, TCS should be the exception with a margin expansion, while Wipro will have the highest erosion (180 basis points) on account of a wage hike, absence of one-time tailwind and Capco impact. In Tier-II IT, Coforge should buck the trend with 200 basis points margin increase, while Zensar Technologies will see a 340 basis points dip due to a wage hike and sales-related investments in 2QFY22,” said Mukul Garg of Motilal Oswal.

Valuations

Continued strong sequential growth momentum and expectation of qualitative commentary on growth beyond FY22 should help sustain the rally in IT stocks, despite their premium valuations.

Motilal Oswal Financial Services is of the opinion that it would be wise to bet on tier-I IT companies at current levels compared to Tier II peers given their relative valuation attractiveness and tendency to narrow down the valuation differential over time.

Within the Tier-I space, the brokerage firm is bullish on Infosys and HCL Tech while L&T Technology Services, Mphasis, Zensar Technologies, and Cyient are its top picks from the tier-II players.