Mr. Amit Chandra, Institutional Research Analyst, HDFC Securities
The IT sector narrative remains positive and the various dashboards and metrics substantiate the progression. The growth outlook is strong with improving probability of sustained momentum, despite the transient supply-side challenges. We 'hit refresh' on the previous quarter metrics across the value chain of our coverage universe. Some of the key observations include: (1) strong momentum/resilience in mid-tier IT (outperformance vs. tier 1s on revenue/margin), which is likely to continue, based on the deal bookings trajectory; (2) slight moderation in tier 1 deal TCV share in Jun-quarter compared to global peers, concurrent with increased growth guidance of global competitors; (3) positive commentary and drivers for software product development and ER&D, supported by IT-OT integration, digital twin and ESG leading to increase in deal size and industry consolidation/inorganic (latest being Akka Tech); (4) our deal tracker data indicating an uptick in the E&U vertical and continuity of strong bookings across the BFSI, healthcare and manufacturing verticals; and (5) an increasing number of larger (multi-year) cloud deals (Azure, AWS), channel expansion (Google Cloud) and strong growth in leading cloud platforms.
The supply-side inflationary scenario (an industry-wide phenomenon) has intensified and attrition (LTM) increased >250bps QoQ, but we believe that these are transient (likely to taper in 1-2 quarters), based on certain interventions, anecdotal evidence, and historical trends. There are multiple levers/interventions (and their inter dependencies) to defend margins against the inflationary impact, which include pricing increase (mid-year revision), further increase in offshore mix (supplemented by extension of return to workplace timelines), scope for pyramid restructuring, and training intensity to support faster deployment of billable resources. Other inter dependencies include profitability focus, supported by staffing concentration in strategic accounts (uptick in USD 100mn+ & USD 10mn+ cohort) and accounts with better margins, in turn supported by strong demand. Mid-tiers do face a bigger hurdle on the supply-side on higher sub-con/lateral dependence and an inflationary gig environment (mid-tier IT sub-con increased 19% QoQ as compared to 11% for tier 1s).
Key hits & misses: IT sector's aggregate performance was largely in line, with 0.4/0.6% variance in revenue/APAT as compared to preview estimates, but the zoom-in to details bring out the interesting stuff. The tier 1 IT revenue outperformance was led by Wipro, TECHM and Infosys while TCS and HCLT were in line to lower then our estimates. Within mid-tiers, the revenue outperformance was more pronounced and broad-based (compared to concentrated pockets in Q4), led by PSYS, MPHL, Mindtree and Zensar.
Outlook and valuations: The YTD EPS upgrades (consensus) have been led by mid-tiers such as TELX, Mindtree, Mastek and PSYS, ranging from 20-40% and, within tier 1, by Wipro (~15%). We expect the sector (coverage universe) to post 13% and 14.5% USD revenue/APAT CAGR over FY21-24E compared to 6.5/7.5% over the past five years. The mid-tier valuation premium relative to tier 1s may sustain, based on its relative outperformance (>500bps growth outperformance over FY21-24E as compared to 250bps earlier). We roll over valuations to Sep-23E and increase target multiples for most of the companies in our coverage universe. We remain broadly constructive across the sector and ahead of consensus on growth/EPS; our preferred picks are Infosys, HCLT, Mphasis and Zensar.