IT sector Q2 preview: Single-digit revenue growth seen, FY25 guidance likely to be revised

Indian IT companies are expected to post single-digit revenue growth of up to 4% in the quarter ended September 30, 2024, according to estimates by three brokerages.

Earnings season begins on Thursday, October 10 with the announcement of results by Tata Consultancy Services (TCS).

The sector is emerging from a severe trough cycle and the recovery may be much faster than expected, BNP Paribas said in a brokerage note. Over the past decade, companies have delivered high-single-digit revenue growth during typical cyclical recoveries and that could be the same this time, BNP said, summarizing current trends in the words of Mark Twain – “History does not repeat itself. But it does.” often rhymes.”

JM expects large-cap IT services players (top-6) to report 0-3.5% constant currency QoQ growth. USD revenue growth could be higher by 10-80 bps. The dollar index (DXY) has recovered 2.4% over the past three months, turning the cross-currency (the joker in the pack) into a tailwind, he said.

Among large-caps, JM expects Infosys to post the highest cc QoQ growth at 3.5%. Wipro and TCS (formerly BSNL) may report flat growth, weighed down by demand slowdown in EU/UK. Among midcaps, momentum should continue in KPIT Technologies (4.6% cc) and Persistent Systems (4%) while Coforge’s reported growth could be higher as it integrates Signity this quarter.

BNP Paribas estimates that midcaps will outperform largecaps. For largecap companies under its coverage, the brokerage expects 2QFY25 cc QoQ organic revenue growth of between 0.2%-1.5% while mid and smallcap coverage reports revenue growth of 2%-4% QoQ. Volume growth and a continued ramp-up of recently won large deals should help drive revenue growth for some companies.

Echoing similar sentiments, Nuwama Institutional Equities said it sees Q2FY25 as a stable quarter, with gradual growth and improvement in companies’ comments. Revenue growth is likely to remain in positive territory for almost all companies (-0.2% and +3.9%) – indicating an overall improving environment, the brokerage notes.

Quality tier-2 companies will continue to outperform their larger peers, Nuwama said, adding that he expects deal flow to remain steady for the overall IT sector, leading to a recovery in the coming quarters.

Earnings season opens on the heels of a 50 bps rate cut by the US Federal Reserve with the possibility of another 50 bps cut this year.

Nuwama expects discretionary spending to recover later and sector growth to revive as this could improve deal-to-revenue conversion.

On the margin front, JM expects large-cap players to report 0-70 bps QoQ earnings before interest and tax (EBIT) margin movement in the July-September quarter. “Other than Wipro (a one-month impact) and TCS (given in 1Q), other large-caps have raised wages. This reflects continued pressure on margins and a still benign supply environment,” the preview note said.

BNP Paribas expects EBIT margin performance to remain mixed on a sequential basis. The recovery seen in the BFSI sector in the last quarter is expected to accelerate in 2QFY25.

Outlook

JM expects Infosys to raise its FY25 guidance to 4-5% cc, from 3-4% currently, implying 0-1% CQGR through 2H. Meanwhile, WPRO is likely to guide for -1% to +1% cc QoQ growth, backing on the impact of furloughs. Meanwhile, HCL should maintain its 3-5% guidance as seasonal strength in the software business is balanced by the anniversary impact of the Verizon deal (Q4). “We expect deal wins to remain steady, albeit on a lower track than FY24’s record run-rate,” JM Knott said.

The industry is now emerging from a low base, a favorable setup to see a strong cyclical recovery in the sector, BNP Paribas said, adding that demand acceleration, led by demand catalysts such as GenAI, will see real, significant upside risks to revenue growth for large IT services companies.

Stock recommendations

So investors should pick stocks where earnings visibility/valuation comfort is high, recommends JM. Infosys, Tech Mahindra and Wipro in the largecap space while Persistent and KPIT are his preferred choices in the midcap segment.

Meanwhile, Nuwama remains positive on LTIMindtree, Infosys, Persistent, Mphasis, Coforge, TCS and HCL Technologies.

Earnings for IT stagnated in the April-June quarter even as the Nifty reported over 5% growth in profit after tax (PAT) in the quarter.

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(disclaimer: Recommendations, suggestions, opinions and views given by experts are their own. (These do not represent the views of The Economic Times)