IT companies are expected to once again start providing guidance due to normalised business activities, which would clear the outlook for the rest of the year. The sector was recently re-rated
MUMBAI: Better deal wins and demand recovery across verticals have seen technology stocks gain ground over the past month. Tier-I technology companies TCS Ltd and Infosys Ltd are also likely to gain from better utilisation and lower operating costs.
But the recent 14% run-up in the Nifty IT index compared to Nifty’s 2% gains may be already pricing in the recovery of second quarter.
TCS and Infosys are expected to lead growth in dollar revenue. A section of the Street is expects TCS to report about 4.5% quarter-on-quarter increase in dollar revenue, which is a decent rebound from sluggish growth in the previous two quarters.
"The deal pipeline continues to be strong, led by traction in client engagement, which is up 3 times vs 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 analysts at Nomura Financial Advisory Services Ltd in client note.
Infosys may of course still pip TCS. The market's dollar revenue growth estimate of 4.7% q-o-q for the company is marginally ahead of that of TCS. The guidance will also be important to watch.
"We expect Infosys to raise its revenue growth guidance for FY21 to 1-3% (vs 0-2% earlier) in constant currency (CC)," said the Nomura report.
A positive fallout of the lockdown has been lower costs which will be a huge factor driving operating leverage this quarter. Tier-I companies are expected to save substantially on costs because of continuing travel restrictions. Besides, utilisation levels of IT companies are rising even as staff salaries are not expected to increase much. These are important tailwinds for the sector. TCS could be the leader with the greatest margin expansion sequentially, followed by Tech Mahindra Ltd.
On the other side of the divide, tier-II companies have not struck too many deals. With tier-I companies averaging 4.1% q-o-q revenue growth, tier-II companies’ revenue growth is expected at 2.9% q-o-q in dollars. Most companies are likely to report about 2-3% growth, considered decent given that they are still emerging from the lockdown. Some companies are likely to report higher margins, but on an average, margins may be lower than those of the top companies.
Nevertheless, IT companies are expected to once again start providing guidance due to normalised business activities, which would clear the outlook for the rest of the year. The sector was recently re-rated.
The Nifty IT Index’s valuation has jumped from 19 times last year to 26 times trailing earnings now, data from Bloomberg show. While this seems to have limited room to expand, better guidance for the rest of the year may support valuations.