Expect IT to zoom if Infosys’ sequential growth is above 7%, ups it dollar revenue guidance for the year above 26%, and gives positive vibes on IT budgets and discretionary spending

Expectations are high on Q3 results and all eyes are focused on information technology, particularly Infosys, which is traditionally among the first to announce its performance. The sector generates special interest because of some important factors like volume growth, (broad-based is better than concentrated), pricing trend (that is not expected to improve), revenue growth in discretionary spend areas (positive expectations), the deal pipeline (and size), net hiring (has been going up), utilisation and attrition. Attrition, which was upwards of 20% for the IT sector in the September quarter, is expected to come down to below 18% for the December quarter.

Strong dollar revenue growth is expected from Tier-1 companies. However, it may not be as strong as it was in the September quarter. TCS, Wipro, Infosys and HCL Technologies are expected to post 5-6% quarter-on-quarter growth.



The banking, financial services & insurance, and retail verticals will probably continue to lead demand revival, while telecom and manufacturing may remain subdued. (The four verticals make up 80% of the business of Indian IT companies.)

The rupee appreciation is expected to play spoilsport. Motilal Oswal says in its preview of the IT sector, "In 3QFY11 the rupee appreciated about 3.3% sequentially and this is expected to play a key role in a 30-50 basis points drop in margins for top-tier companies. Companies like Infosys and TCS have a near 40 basis points EBIT sensitivity to a one percentage point change in the rupee/dollar. We expect no revival in HCL Tech's EBITDA margins, though it has maximum upside on margins due to levers like utilisation, SGA (selling, general and administrative expenses) and the employee pyramid." However, not everybody is expecting a margins drop.

There are no real hopes of any price increase this quarter. Headcount additions are expected to be strong.



Infosys Technologies (Q3)

Infosys, India's second largest IT company by sales, had given guidance for dollar revenue growth of 3.4%-4.4% quarter-on-quarter, but most expect it to produce one of the strongest figures among Tier-1 IT companies at more than 6%. Margins are expected to appreciate a bit; volumes could be higher by more than 6%. Infosys will probably manage margins by controlling SGA expenses. CLSA believes that the absence of visa costs should drive a positive surprise on margins.

It is expected to upgrade its dollar revenue guidance (24-25% in 2QFY11). However, this upgrade may not be very aggressive given that fourth quarter (March) revenues usually tend to decelerate over the December quarter. Rupee EPS guidance could be revised upwards of Rs 120 (currently at Rs 117).



HCL Technologies (Q2)

HCL's infrastructure management segment is expected to give good returns. Forex losses may be behind it from this quarter onwards.



TCS (Q3)
Like Infosys, TCS is expected to grow more than 6% (revenue in dollars) quarter-on-quarter with a 6% plus volume growth. Motilal says, "TCS' continued cost aggression over the past six quarters leaves it with limited cushion for margin upsides."



Wipro (Q3)

Revenue growth is expected at around 5.5% at the higher end of its guidance. Watch out for impact of promotions on IT margins, attrition and the next quarter's guidance.



Even though large-cap IT stocks look fairly valued at 20-23 times their one-year forward earnings, there is a lot of interest in them at the moment because of the belief that there is an upside for their earnings. The two biggest risks for the sector continue to be the significant rupee appreciation and a sudden fall in US growth rate.