IT Sector Q2FY21 Results Preview - On recovery trajectory - HDFC Securities

Mr. Apurva Prasad, Institutional Research Analyst, HDFC Securities & Mr. Amit Chandra, Institutional Research Analyst, HDFC Securities

The IT sector (coverage universe) is expected to bounce back to +3.2% QoQ in 2QFY21E, following a 6% QoQ decline in 1QFY21. We expect tier-1 IT to deliver revenue growth in the range of -0.5% to +3.5% QoQ in CC terms, and expect an additional cross-currency impact in the range of +140-170bps QoQ. Growth is backed by (1) strong deal flow (pipeline/conversion), (2) improvement in execution (transition timelines and reversal in supply-side challenges). The three enormous industry tailwinds for Indian IT which are supporting broad-based acceleration include: (1) increase in priority for tech spend/budgets over other budgets for enterprises, (2) compression of timelines for core IT systems transformation, cloud migration and multi-cloud interoperability, and (3) vendor consolidation (partner-led engagements, large deal constructs, and higher existing customer CSAT led).

Deal momentum has been strong across the sector in 2Q, and we expect deal TCV to be robust for TCS (Phoenix, Morrisons, Coop, and ABB), Infosys (Vanguard and ConEd), HCLT (Ericsson), Wipro (Marelli), Mphasis (RBS), and Mindtree (Husqvarna). The partner ecosystem continues to expand, led by HCLT with Google, Nvidia, Broadcom, and Temenos; TCS, TechM, Mindtree, LTTS and Birlasoft with Microsoft; Persistent with AWS. Accenture also recently highlighted strong growth in outsourcing deal bookings and a pick-up in large deals (Atos-Siemens). Key industry lead indicators such as tech spend by large global BFSIs, growth in leading SaaS/PaaS are encouraging.

Profitability is expected to improve in 2QFY21 supported by (1) better efficiency (depressed travel and event cost and optimal sub-contracting and SG&A), (2) operating leverage supported by better utilisation, and (3) cross-currency (EUR/GBP/AUD) tailwinds offset by USD-INR. Aggregate sector margin is expected to increase by +74/64bps QoQ/YoY with stronger expansion in tier-2 (+90/106bps QoQ/YoY).

Revenue outperformance led by HCLT/INFY in tier-1 and PSYS/ MTCL/MPHL in mid-tier: We expect TCS/INFY/HCLT/WPRO /TECHM to post QoQ CC growth of +1.7%, +2.0%, +3.5%, -0.7% (organic) and +1.1% respectively for 2QFY21E. Within mid-tier, we expect PSYS, MTCL and MPHL to lead QoQ CC growth at +2.5%, +2.3% and +2.0% respectively. 2Q growth laggard is expected to be WPRO from tier-1 and CYL/ZENT from mid-tier. Operationally, TCS/TECHM is expected to post strongest margin expansion QoQ, while CYL and SSOF could post the strongest QoQ margin gains within mid-tier.

Key monitorable: (1) Progression/regression on large deals and overall deal bookings, trends in reversal/extension of temporary pricing/volume discounts (2H growth lever), (2) outlook on large verticals such as BFSI, Retail & CPG and commentary on tech spend propensity in enterprise clients, (3) outlook on delivery model changes (WFH, localisation) over medium-term, which has an implication for margin and investments, (4) DSO trends (expected to remain stable QoQ following the reduction in 1Q) and capital allocation plans (payout vs. inorganic).

Reiterate positive outlook: Despite the recent outperformance/re-rating (valuations at +2SD with IT index outperforming NIFTY by 17/20% over 3M/6M), we remain positive on the sector based on (1) growth longevity and acceleration (FY21-23 incremental revenue growth > FY17-21 period, factoring -2.0%, +9.8%, +8.7% USD revenue growth by tier-1 in FY21/22/23E), and (2) resilient service portfolio (tier-1 IT aggregate to reach pre-COVID revenue by 3QFY21) even in an extended pandemic scenario. Key risks are intermittent volatility with upcoming US elections and unfavourable USD-INR swing. We roll forward valuations to Sep-22E, and our preferred picks include Infosys, HCL Tech, Mphasis, LTI, Persistent, Sonata and Mastek.

Exchanges and Staffing

Within exchanges, MCX is expected to post a 59.9% QoQ increase in revenue due to 64.4% QoQ rise in ADTV, led by bullion. Margins will expand 1,407bps QoQ to 50.4% due to non-linearity. Volatility in major global commodities, a strong recovery in ADTV and regulatory tailwinds (launch of indices) are positives.

BSE has registered some recovery in the core business performance (cash volume up 11% QoQ), but the cash market share slipped to 5.9% (down 37bps QoQ). BSE has gained 3% market share in derivatives, which will help in regaining lost ground in cash segment. The net cash (excluding SGF and clearing cash) is ~73% of market cap and value of CDSL stake after 25% discount is Rs 165/share. We upgrade BSE to BUY with a target price of Rs 670, based on 10x core Sep-22 PAT + net cash + CDSL stake.

CDSL will have a robust 2Q with 9.9% QoQ growth, led by transaction and online data charges. Transaction revenue is witnessing strong traction led by higher volume boost and higher retail penetration. The recent SEBI directive related to margin requirement has led to higher pledge creation. This will also boost the transaction revenue as CDSL charges Rs 5/pledge creation. Online e- KYC approval and market traction is boosting online data charges. The EBITDA margin will expand by 275bps QoQ to 61.1% and PAT will be flat QoQ due to low other income.

Within staffing, Teamlease will post a stable quarter with 1.8% QoQ growth in revenue, led by a recovery in core staffing. The demand recovery is stronger in the month of Sep-20 and is likely to continue in the festive season, as the economy is gradually opening up. The EBITDA margin will improve by 11bps QoQ to 2.3%, based on continuous cost-cutting and improving business mix (high-margin specialised staffing).

Source : Equity Bulls

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