TCS and Infosys are likely to report 2.5 to 3% q-o-q growth in Q2 in constant currency terms
But, thanks to the lead Infosys had in previous quarters, TCS may lag Infosys on a y-o-y basis
Technology stocks have staged a recovery lately on expectations that the second quarter could show improvement. On that count, the numbers may not disappoint. Better deal wins and demand recovery across verticals could well aid revenue growth for tier-1 firms. Still, the recent 16% run-up in the Nifty IT Index compared to Nifty 50’s 3% gains may be already pricing in the second-quarter recovery.
Both Tata Consultancy Services Ltd (TCS) and Infosys Ltd are likely to report decent 2.5% to 3% sequential growth in Q2 in constant currency terms, on the back of revenue accretion from recent large deals.
But thanks to the lead Infosys has taken in previous quarters, TCS is expected to lag Infosys on a year-on-year (y-o-y) basis. Kotak Institutional Equities analysts estimate 4% y-o-y decline in dollar revenues at TCS, as compared to a 1% y-o-y increase in the case of Infosys.
Besides headwinds for certain clients in some sectors, TCS also faced higher supply-side issues, which affected performance in Q1.
Now that these are resolved, growth is expected to be better on a sequential basis. “Covid-19 has acted as a catalyst for acceleration in IT spends. We believe that global outsourcing spending will accelerate from 4-5% pre-covid level numbers," said Kotak Institutional Equities analysts in a client note.
“The deal pipeline continues to be strong, led by traction in client engagement, which is up three times versus pre-covid levels. Further, TCS announced 10 deals in Q2 FY21 which should help sustain the overall momentum on deal wins similar to prior quarters," said Nomura Financial Advisory Services Ltd analysts in a client note.
Meanwhile, HCL Technologies Ltd could pip the two and show better revenue growth. Importantly, investors will also be watching the guidance for the full year.
“We expect Infosys to raise its revenue growth guidance for FY21 to 1-3% (vs 0-2% earlier) in constant currency terms (CC)," said the Nomura report.
IT companies are also expected to post stable margins, thanks to better utilization and lower operating costs.
Cost savings can further drive improvement in operating leverage. Continuing travel restrictions and better utilization of staff is likely to reflect on improving margins. These are important tailwinds for the sector. TCS could be the leader with the biggest margin expansion sequentially, followed by Tech Mahindra Ltd.
Even so, the sector already reflects the higher expectations. The Nifty IT Index’s valuation has jumped from 19 times last year to 26 times trailing earnings now, data from Bloomberg showed. While this seems to have limited room to expand, better guidance for the rest of the year may support valuations.