Home >Markets >Mark To Market >Unseasonally jolly: the market is upbeat about IT cos’ Q3 earnings

It looks like Indian IT companies have a spring in their step. The Street has raised the bar as far as expectations for third-quarter results go, with the sector estimated to report its best Q3 results in a decade. That is also adding to the bounce in IT stocks. The Nifty IT index is up about 20% in the past two months, and valuations have re-rated significantly in the past year.

The December quarter is typically a lean period for IT companies. The strong demand witnessed this time around is unusual, causing brokers such as Kotak Institutional Equities to use terms such as “unseasonally jolly" in the results preview reports.

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Tech firms are ramping up their deliveries as global IT spends continue to remain robust. In addition, after strong earnings from Accenture, and with the US presidential election behind, the Street is expecting an outperformance in Q3 against management guidance. Indeed, Accenture’s recent earnings showed demand normalization and a good recovery.

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“Indian IT companies are poised to turn in the best Q3 in a decade, given highest-ever order books, marked revenue acceleration, margin expansion and ongoing outlook upgrades," said Edelweiss Securities Ltd in a client note. Analysts at Kotak Institutional Equities add that many Indian IT companies will return to posting year-on-year growth in Q3, and that there could be revenue estimate upgrades during the current results season.

Besides, margin expansions could also be on the cards. While some companies have announced wage hikes, overall margins for tier-1 tech companies may not have a huge impact because of better operating leverage. Besides, expenses such as travel and marketing events haven’t made a comeback, supporting margins.

Overall, revenue growth for tier-1 and tier-2 tech companies is expected to be around 3.7% in US dollars terms, sequentially. This compares with 1.9% growth in the year-ago quarter.

Further, the Street is also expecting companies to raise their guidance for the coming quarter, given the good deal wins seen lately. Global tech companies are seen as upfronting technology spends. Deal wins have been strong in Q3, with companies such as Tata Consultancy Services Ltd, Wipro Ltd and Infosys Ltd bagging some big deals.

But given that IT stocks have seen a sharp run-up in the past few months, the stock valuations are not inexpensive. “Stocks have rallied in the past six months and are trading at a 30-50% premium on our one-year forward earnings per share against past five-year average," noted analysts at Nomura Financial Advisory and Securities (India) Pvt. Ltd in a client note.

Unless there is a meaningful upside in earnings in FY22 compared to estimates, the current valuations may see stocks tapering off post-earnings. The price-earnings multiple of the Nifty IT index is now at 27.6 times, compared to 17.2 times a year ago. Earnings expectations for FY22, however, remains the same it was a year ago.

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