04 July 2020
1Q dent, stability and recovery ahead IT sector (coverage universe) is expected to post -6.1/-3.7% QoQ/YoY in 1QFY21E revenue with cross-currency impact of -15 to -70bps QoQ. We expect Tier-1 IT revenue to decline between 5% and 9% QoQ while Tier2 IT is expected to display a wider divergence (-2 to -14% QoQ). COVIDrelated economic impact on sectors like travel and transportation, O&G, retail & CPG (discretionary) will be accentuated in 1Q (dual impact of price/volume cuts and deal deferrals/cancellations), while BFSI, healthcare, retail & CPG (non-disc.) and hi-tech verticals will be more resilient (deal-deferral impact, but resilient on pricing/volume).
We expect demand recovery from 2Q-3Q, supported by (1) strong digital playbook, (2) recovery in deal contracting with increase in consolidation deals (advantage Indian Tier-1s) as enterprises consolidate their tech portfolio, and (3) tech budget normalisation in 2Q for impacted verticals. Following -1.5/-6.0% QoQ in 4Q20/1Q21E, we have factored – 0.6/+1.5/+2.8% QoQ in revenue over 2Q-4Q21E. The IT sector margin is expected to decline 95bps QoQ. Profitability is expected to be impacted by lower utilisation, pricing, cross-currency (GBP), lower forex gains and should be offset by (1) INR depreciation, (2) lower travel and discretionary spend, (3) deferral of wage increase and variable payouts cuts/deferrals, and (4) lower sub-contracting. We expect the margin trajectory to bottom out in 2Q. Subsequent margin recovery is premised on (1) demand recovery leading to utilisation recovery (onsite utilisation to precede offshore), and (2) continuity in optimal SG&A, including travel and sub-contracting rationalisation.
§ LTI/Mindtree to outperform on margins, PSYS on revenue:
Within Tier-1 IT, TCS/INFY/HCLT/Wipro/TechM are expected to post -5%, – 5.5% (organic), -5.6%, -6.4%, -9.3% (organic) QoQ CC respectively. Within Tier-2 IT, Persistent is expected to outperform on a QoQ basis, while Cyient, LTTS and Sonata are expected to underperform. We also expect LTI and Mindtree to exhibit the highest margin resilience as compared to peers, while Cyient and Zensar take the biggest margin knock.
§ Key monitorables:
- Progression/regression in large deal pipeline and bookings and virtual framework for pipeline conversion/execution, (2) systematic risk in portfolio and tech spend propensity in enterprise-clients across verticals, and (3) DSO trends (expect moderate impact in 1Q) and capital allocation (payout) plans. While IT index has re-rated to pre-COVID valuations, risk-reward remains favourable as (1) valuation gaps within Tier-1s have increased (TCS/INFY valuations re-rating vs. HCLT/Wipro/TechM de-rating compared to average), and (2) IT index discount to benchmark, following underperformance in 3M period. Prefer Infosys, HCLT, LTI, Mphasis and Sonata.
Exchanges and Staffing
§ Within exchanges, MCX is expected to post 39.5% QoQ drop in revenue due to 36.9% fall in ADTV. Margins will be under pressure (-1,215bps QoQ) due to nonlinearity. Positives such as volatility in major global commodities, recovery in ADTV (June-20) and regulatory tailwinds (indices) are holding up valuations. On the contrary, BSE has registered some recovery in the core business performance (cash volume up 12% QoQ), but the cash market share slipped to 6.2% (down 67bps QoQ). The net cash (excluding SGF and clearing cash) remains at 85% of market cap.
CDSL (top pick) will have a good 1Q with 6.7% QoQ growth, led by transaction and online data charges. Transaction charges have recovered strongly and e-KYC is boosting online data charges. The EBIT margin will expand by 206bps QoQ to 54.7% and PAT will recover 29.1% QoQ due to the absence of one-off charges. § Within staffing, Teamlease will post a weak quarter with 13.3% QoQ decline in revenue due to 14.8% drop in core staffing. The margin will improve by 44bps QoQ on cost cutting and better business mix (higher-margin specialised staffing).
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