IT: Forget Q3 results, focus on commentary

Wide-held expectations are that year-on-year (y-o-y) revenue growth will start gradually improving from Q3FY25 onwards. (Mint)
Wide-held expectations are that year-on-year (y-o-y) revenue growth will start gradually improving from Q3FY25 onwards. (Mint)

Summary

  • The Street is more concerned about the outlook for discretionary IT demand, budget indicators for 2025, and prospects of short-duration deals.

The December quarter (Q3FY25) is seasonally weak for the Indian IT sector due to furloughs and fewer working days. Thus, no fireworks are anticipated. Since expectations are already low, Q3 results would offer little help in gauging demand momentum.

Even so, wide-held expectations are that year-on-year (y-o-y) revenue growth will start gradually improving from Q3FY25 onwards, aided by lower project cancellations, the beginning of the US Federal Reserve's interest rate cut cycle, and the end of uncertainties surrounding the US election.

However, sequential performance will be muted.

Also Read: Indian IT services companies shed reliance on H-1B visas

“We expect aggregate revenue growth for our coverage to moderate slightly in Q3 to 0.7% quarter-on-quarter (q-o-q) constant currency (3.9% y-o-y constant currency), given the usual furloughs," said a 31 December Jefferies India report. The divergence between tier-1 and tier-2 would persist, with the latter continuing to outpace the former in revenue growth.

Street concerns

However, the Street is more concerned about the outlook for discretionary IT demand, budget indicators for 2025, and prospects of short-duration deals, which have been muted lately.

Segment-wise, while some recovery is likely in the banking financial services and insurance (BFSI) vertical, weakness in manufacturing and retail could hurt. Cost optimization deals are expected to remain a priority for clients.

Region-wise, Europe could remain a drag; the sustenance of green shoots in the North American market would be closely watched.

Also Read: For Afcons, Vadhvan Port can be a big opportunity

Global IT major Accenture has not seen a material change in demand, it said in its earnings call in December. Accenture’s result is often seen as an indicator of the future performance of tier-1 Indian IT firms. It also signalled pricing pressure due to elevated competition amid a constrained client budget scenario. A worry is that the US Fed’s recent hawkish tone on future interest rate cuts might influence client budgets. Typically, clarity on client budgets emerges by January/February.

“Don’t expect much clarity to emerge as clients might wait for (Donald) Trump to take office (20 January) before firming up their plans," said a JM Financial Institutional Securities report on 31 December. “Any spillover of furloughs (like FY24) into Q4 could be concerning. Durability of smaller deals could be a precursor to discretionary spend revival," it added.

Accenture raised its FY25 guidance constant currency revenue growth guidance to 4-7% from 3-6% earlier. So, an upward revision by tier-1 Indian IT companies Infosys Ltd, HCL Technologies Ltd and Wipro Ltd would be a sentiment positive, while narrowing guidance would be a dampener.

Margin expectations

Margin movement can vary across companies depending on company-specific factors such as salary hikes, large deals ramp-ups and changes in business mix. Wipro Ltd, LTIMindtree Ltd and Cyient Ltd could report a sequential margin fall due to wage hikes.

Also Read: India’s share in global market capitalization eases from all-time high

“For tier-1 companies, we expect margins to see a fluctuation of –140 basis points (bps) to +100bps, while we expect margins to vary by -160bps to 60bps q-o-q for mid-caps," said a 1 January Emkay Global Financial Services report. One basis point is one-hundredth of one percentage point.

The rupee’s depreciation against the US dollar could buoy margins to some extent sequentially in Q3FY25.

Meanwhile, the Nifty IT Index has rallied by 26% so far in FY25, beating Nifty 50’s single-digit returns. The up move is fuelled by rising hopes of revenue recovery in FY26 and the rupee’s depreciation that has led to a re-rating in IT stocks. Earnings upgrades would depend on whether the pace of revenue growth is able to meet the Street’s elevated expectations.

According to Jefferies, Nifty IT valuations at 28x price-to-earnings multiple are 25% premium to the five-year average and 45% premium to the Nifty 50, thus leaving little room for disappointment.

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
more

topics

MINT SPECIALS