IT Sector
Institutional Equity Research
Results Preview | July 10,2017
Currency Fluctuations to Add to the Woes
Sector Preview
Revenue Growth to Remain Subdued
We expect the IT firms under our coverage universe to post a combined 2.2% QoQ rise in USD revenue in
1QFY18. We expect the Top-5 IT firms to post 0-3% QoQ USD revenue growth in reported terms (0-2% in CC
terms), with Tech Mahindra (TechM)and HCL Tech (HCLT) to lead the show. Mid-sized firms will see variation,
with Mindtree and Cyient likely to lead (4.6% and 2.8% QoQ USD revenue growth, respectively). A positive
in 1QFY18 is favourable cross-currency movements, with the USD depreciating against the EUR and GBP
by ~3%, which will positively impact reported USD growth numbers by 30-90bps. However, the USD also
depreciated against the INR by~4% QoQ, which will adversely affect reported INR numbers and EBITDA
margins by~80-100bps.
We expect 2.2% sequential revenue growth for the IT firms under our coverage universe, while YoY growth is
likely to remain subdued at 5.9%, partly owing to adverse cross-currency impact and increasing competitive
intensity and pricing pressure. Favourable cross-currency movements (GBP, EUR depreciated by ~3% QoQ
vs. USD) will have a positive impact to the tune of 30-90bps on reported USD growth numbers. However,
this will be offset by INR appreciation vis-à-visUSD to the tune of~4% QoQ, leading to reported INR growth
numbers coming in at -6% to +1% QoQ. Company-wise, we expect TechM and HCLT to outperform their
peers among top-tier IT pack (+4% and 3.1% QoQ, respectively), while Mindtree and Cyient are likely to
outperform the mid-sized firms (+4.6% and 2.8% QoQ, respectively). Wipro, KPIT Technologies and eClerx
are likely to under-perform their peers. We believe factors like SMAC, challenging macro scenario, high
competitive intensity and pricing pressure will sustain and impede growth over the next few quarters as
well.
The IT sector is already facing significant headwinds and disruptive trends, and INR appreciation will further
exacerbate the scenario.The IT Industry body, NASSCOM has projected a 7-8% growth in IT-BPO exports
in FY18, with the announcement coming as late as June 22 this time vs. the normal practice of providing
industry growth guidance in February, owing to global uncertainty. Thus, in addition to the current issues
faced by the industry, with revenue and profit growth hard to come by, INR appreciation makes it even more
challenging for the sector.
On margin front,we expect most firms to post 60-160bps sequential decline owing to appreciation, growth
challenges and higher visa cost. Within our coverage universe, Wipro, TechM and Mindtree are likely to post
improved margins owing to growth and lack of anyone-time cost. We expect continuous focus on levers like
utilisation and cost efficiencies. On YoY comparison,barring Infosys, Wipro and Hexaware, all IT firms are
likely to see lower margins in the range of 50-620bps.
We would watch for sustainable margin outlook and IT budget trend. Focus on return of cash to shareholders
is also a theme playing out, with TCS, HCLT, Hexaware, Mindtree and eClerx all resorting to share buy backs
in order to make better usage of their cash balances. We continue to believe Indian IT is a bottom-up sector
and judicious stock picking will play a key role in driving alpha.
Our Top Picks: HCLT among the large-caps, Cyient and Sonata among the mid-caps.
Margins to Weaken on Currency Woes, Higher VisaCost
Margins are likely to see 60-160bps sequential decline owing to INR appreciation and higher visa cost. On
YoY basis – barring Infosys, Wipro and Hexaware – margins would see across-the-board decline in the
range of 50-620bps. Five out of the top and mid-tier IT firms under our coverage will report an absolute YoY
decline in EBIT, ranging between 2-20%. Client specific issues, challenging macro environment and vertical/
service specific headwinds would continue to impact profitability.
Focus on Guidance Maintenance, Cash Return
In our view, the street’s attention will be focused on revenue guidance/qualitative outlook and return of cash
to shareholders. We believe maintaining status quo in current guidance/qualitative outlook and incremental
progress on return of cash to shareholders will be viewed as positives. The business environment remains
challenged with protectionism in key geographies like the US, UK and Australia continuing to be a key
concern, while disruptive trends, especially SMAC are likely to continue to erode IT firms’ incremental
prospects. In this context, maintaining margins within a narrow band at least until revenue growth sees a
sustainable up-tick assumes importance. The increasing role of automation and other margin levers are
critical in our view.
Research Analyst: Harit Shah
Contact: (022) 33201276
Email: [email protected]
1 1
IT Sector
Institutional Equity Research
Results Preview | July 10,2017
Exhibits 1: Result Preview for stocks under coverage
Company
1QFY18E
4QFY17
QoQ %
1QFY17
YoY %
Comments
Tata Consultancy Services
Revenue (US$ mn)
4,563
4,452
2.5
4,362
4.6
Revenue (Rs bn)
296.6
296.4
0.1
293.1
1.2
EBIT (Rs bn)
71.7
76.3
(6.0)
73.5
(2.4)
EBIT margin (%)
24.2
25.7
(156) bps
25.1
(90) bps
EPS (Rs)
32.7
33.5
(2.5)
32.1
2.0
Revenue (US$ mn)
2,623
2,569
2.1
2,501
4.9
Revenue (Rs bn)
169.0
171.2
(1.3)
167.8
0.7
USD revenue is expected to grow by 2.5% QoQ, CC revenue is pegged at 1.6% QoQ; INR appreciation,
visa cost to lead EBIT margin decline
Key Factors to Watch Out For: IT budget trend and client commentary, focus on return of cash,
acquisitions
Infosys
EBIT (Rs bn)
40.7
42.1
(3.5)
40.5
0.5
EBIT margin (%)
24.1
24.6
(55) bps
24.1
(6) bps
EPS (INR)
15.7
15.8
(0.6)
15.0
4.2
Revenue (US$ mn)
1,948
1,955
(0.3)
1,931
0.9
Revenue (Rs bn)
USD revenue is expected to rise by 2.1% QoQ, CC revenue growth is pegged at 1.5% QoQ; margin
todecline owing to INR appreciation, visa
Key Factors to Watch Out For: Maintenance of FY18 guidance, deal wins, cash return through modes
other than dividend
Wipro*
134.9
144.0
(6.3)
137.0
(1.5)
EBIT (Rs bn)
25.0
24.1
3.8
22.8
9.4
EBIT margin (%)
18.5
16.7
179 bps
16.7
184 bps
9.5
9.2
3.4
8.3
14.0
EPS (INR)
USD revenue is expected to de-grow by 0.3% QoQ, CC de-growth is pegged at 1.2% QoQ; EBIT margin to
see improvement on cost control and lack of one-time items in 4QFY17
Key Factors to Watch Out For: 2QFY18 rev growth guidance, developments on cash return
Continued...
2
2
IT Sector
Institutional Equity Research
Results Preview | July 10,2017
Result Preview for stocks under coverage
Company
1QFY18E
4QFY17
QoQ %
1QFY17
YoY %
Comments
HCL Technologies
Revenue (US$ mn)
1,873
1,817
3.1
1,691
10.8
Revenue (Rs bn)
120.7
120.5
0.2
113.4
6.5
EBIT (Rs bn)
23.4
24.2
(3.3)
23.3
0.2
EBIT margin (%)
19.4
20.0
(69) bps
20.6
(122) bps
EPS (Rs)
14.5
16.5
(12.0)
14.5
(0.0)
Revenue (US$ mn)
1,176
1,131
4.0
1,032
14.1
Revenue (Rs bn)
USD revenue is expected to grow by 3.1% QoQ, CC growth is pegged at 2.2% QoQ; currency to impede
EBIT margin
Key Factors to Watch Out For: Deal wins, reiteration of FY18 guidance and budget commentary
Tech Mahindra
75.8
75.0
1.2
69.2
9.6
EBIT (Rs bn)
6.7
6.2
9.3
8.3
(18.7)
EBIT margin (%)
8.9
8.2
66 bps
12.0
(308) bps
EPS (Rs)
7.4
6.6
12.6
8.4
(11.8)
Revenue (US$ mn)
205
196
4.6
199
2.8
Revenue (Rs bn)
13.2
13.2
0.2
13.3
(0.5)
1.4
1.2
17.4
1.5
(7.1)
10.4
8.9
153 bps
11.2
(74) bps
7.0
5.8
21.5
7.3
(4.4)
USD revenue is expected to grow by 4% QoQ (including acquisitions), CC growth is peggedat 3.2% QoQ,
margins to rise on cost control and lack of one-time items
Key Factors to Watch Out For: Telecom growth, deal wins on enterprise side, IT budget commentary and
comments on wage hikes
Mindtree
EBIT (Rs bn)
EBIT margin (%)
EPS (Rs)
USD revrevenueis expected to rise by 4.6% QoQ, CC growth is pegged at 3.9% QoQ; margins to improve
on revenue growth and improving subsidiary profitability
Key Factors to Watch Out For: Reiteration of FY18 outlook of low double-digit CC growth, order book and
digital revenue growth
Continued...
3
3
IT Sector
Institutional Equity Research
Results Preview | July 10,2017
Result Preview for stocks under coverage
Company
1QFY18E
4QFY17
QoQ %
1QFY17
YoY %
Comments
Cyient
Revenue (US$ mn)
145
141
2.8
125
16.2
Revenue (Rs mn)
9.4
9.4
0.0
8.3
12.7
EBIT (Rs mn)
0.9
1.0
(11.6)
0.9
1.4
EBIT margin (%)
9.3
10.6 bps
(122)
10.4
(104) bps
EPS (Rs)
9.0
7.0
29.3
6.6
37.2
Revenue (US$ mn)
149
145
2.7
130
14.6
Revenue (Rs bn)
9.6
9.6
(0.3)
8.7
10.1
EBIT (Rs bn)
1.5
1.5
4.7
1.2
26.2
16.0
15.3
76 bps
14.0
204 bps
4.0
3.8
4.8
3.3
20.1
Revenue (US$ mn)
130
128
1.0
120
8.2
Revenue (Rs bn)
8.4
8.6
(2.7)
8.0
4.0
EBIT (Rs bn)
0.5
0.6
(14.6)
0.7
(20.4)
EBIT margin (%)
6.4
7.3
(88) bps
8.3
(195) bps
EPS (Rs)
2.1
2.7
(22.8)
2.8
(24.5)
USD revenue expected to rise 2.8% QoQ, CC growth likely at 2.3% QoQ; margins to dip on currency
pressures
Key Factors to Watch Out For: Reiteration of FY18 growth outlook of double digit revenue growth in the
core business, 50 bps margin expansion and double digit earnings growth
Hexaware Technologies**
EBIT margin (%)
EPS (Rs)
USD revenue is expected to grow by 2.7% QoQ, CC growth is pegged at 2.3% QoQ, margins to see rise
on cost control and revenue growth
Key Factors to Watch Out For: Reiteration of 10-12% revenue growth guidance for CY17
KPIT Technologies
USD revrevenue is expected to grow by 1% QoQ, CC growth is pegged at 0.5% QoQ, margins to decline
on INR appreciation, to be offset by utilisation and off-shoring
Key Factors to Watch Out For: Margin outlook for FY18 in light of strong INR, time frame for revenue
growth recovery and recovery in IES business growth
Continued...
4
4
IT Sector
Institutional Equity Research
Results Preview | July 10,2017
Result Preview for stocks under coverage
Company
1QFY18E
4QFY17
QoQ %
1QFY17
YoY %
Revenue (US$ mn)
111
Revenue (Rs bn)
7.1
109
1.6
105
5.7
7.3
(1.8)
7.0
1.7
EBIT (Rs bn)
0.7
0.9
(24.2)
0.7
(3.7)
EBIT margin (%)
9.6
12.5
(284) bps
10.2
(54) bps
EPS (Rs)
9.0
10.5
(14.1)
9.2
(1.3)
48
48
1.0
50
(3.6)
Revenue (Rs bn)
3.1
3.3
(5.9)
3.4
(8.4)
EBIT (Rs bn)
0.9
0.9
(4.1)
1.1
(25.4)
EBIT margin (%)
27.3
26.7
53 bps
33.5
(623) bps
EPS (Rs)
20.5
18.7
9.8
23.2
(11.7)
Comments
Persistent Systems
USD revenue is expected to grow by 1.6% QoQ, margins to fall on currency headwinds
Key Factors to Watch Out For: Revenue growth outlook, IBM IoT deal trend, ISV business growth and
potential for margin expansion
eClerx Services
Revenue (US$ mn)
USD revenue is likely to grow by 1% QoQ on continuing challenges, automation, subdued outlook,
margins to rise by 53bps QoQ on better cost efficiencies
Key Factors to Watch Out For: Time frame for revenue growth recovery, outlook for non-cable businesses
Majesco Limited
Revenue (US$ mn)
30
28
6.9
33
(7.6)
Revenue (Rs bn)
1.9
1.9
3.3
2.2
(10.3)
EBIT (Rs bn)
0.0
0.1
(50.9)
0.0
79.0
EBIT margin (%)
1.5
3.2
(169) bps
0.8
76 bps
EPS (Rs)
0.6
1.0
(36.6)
0.6
0.9
31
31
2.5
29
7.8
USD revenue growth is likely to grow by 6.9% QoQ, with client specific issue behind and new deal wins
Key Factors to Watch Out For: Order book and new client growth, 2Q growth outlook and progress on
implementation of work in the delayed deal
Sonata Software
IITS Revenue (US$ mn)
Cons. Revenue (Rs bn)
8.1
7.1
15.0
6.8
20.2
Cons. EBIT (Rs bn)
0.4
0.4
8.3
0.4
6.6
EBIT margin (%)
5.5
5.8
(34) bps
6.2
(70) bps
EPS (Rs)
4.1
3.8
6.2
3.5
16.6
USD revenue growth is seen at 2.5% QoQ in the IITS business, total revenue is expected to rise by 15%
QoQ on seasonally strong DPS business
Key Factors to Watch Out For: IITS revenue growth, FY18 outlook, OPD vertical growth recovery and
sustainable margins
Note: * Revenue in USD terms refers to combined IT service revenue, while in INR terms it refers to consolidated revenue
** Hexaware has a December-ending FY; thus, 1QFY18E=2QCY17E
5
5
IT Sector
Institutional Equity Research
Results Preview | July 10,2017
Top Picks
HCL Technologies
ff Fastest USD revenue growth among top-tier IT firms, at 12% CAGR over FY17-FY19E.
ff Deal momentum remains strong, with US$1 bn wins every quarter, providing good revenue
visibility and confidence.
ff Strong growth potential in IMS business(40% of revenue), one of the largest IMS practices in the
industry (23% YoY USD revenue growth in 4QFY17) .
ff Select acquisitions (Geometric) and IP deals (recent US$350mn deal with IBM) aimed at enhancing
capabilities in fast-growing areas like engineering services and automation, which are likely to
sustain revenue growth and drive non-linearity.
ff Confidence to provide revenue and margin guidance from FY17 is a heartening sign, particularly
in the context of the challenging macroeconomic environment; we believe the stock deserves a
higher multiple for greater transparency.
ff Valuation is very reasonable at 12.3x FY18E EPS in light of good revenue growth and healthy RoE
(27.5%).
We assign BUY recommendation on HCLT with a Target Price of Rs963.
Cyient
ff Cyient’s core services business (ex-Rangsons) has seen sharp recovery in USD revenue growth
over the past 5 quarters. USD revenue growth came in at 15.4% YoY in 4QFY17, marking the 3rd
successive quarter of double-digit growth and the fastest growth since 3QFY15, attributable to
healthy growth in Communications, Utilities, Medical & Transportation verticals.
ff Over 70-75% of Cyient’s revenue is witnessing good traction, which we believe will drive doubledigit growth in USD revenue in Cyient Services in FY18E & FY19E. We believe this is the key factor
that warrants a stock re-rating.
ff Marquee client base, long-term client relationships and introduction of newer practices (DLM,
Medical & Healthcare) ensconce Cyient’s position in its core areas of expertise; for example, Cyient
has a 16-year relationship with Pratt & Whitney, a global major in the design and manufacture of
aircraft engines and equipment.
ff Consistent expansion of capabilities into newer domains i.e. Utilities has driven growth, which is
likely to sustain in FY18E & FY19Eas well.
ff EPS is expected to record a healthy 21% CAGR over FY17-FY19E led by strong revenue growth and
cost control.
ff Cyient’s dividend payout ratio was ~34% of PAT in FY17 (dividend yield 2.5%); gross and net cash
& cash equivalents were Rs9.7bn & Rs8.1bn, respectively as of FY17-end (Rs1.4bn dividend + DDT
paid). We expect sustained high dividend payouts, boosting confidence on cash generation ability
for capex and strategic acquisitions.
We assign BUY recommendation on Cyient with a Target Price of Rs565.
Sonata Software
ff A major focus area for Sonata is software platforms – both horizontal and vertical. Platform &
New Services – contributed a substantial 38% to total revenue in 4QFY17. With 12.1% USD revenue
CQGR over the past 8 quarters, the Infrastructure Management Services (IMS) business has been
a major success story for Sonata, accounting for 19% of revenue in 2QFY17 vs. 9% in 4QFY15.
ff Sonata’s dividend payout has consistently been on the higher side, with the same at 37.6% in
FY17; we expect high dividend payouts to sustain, going forward. Sonata had gross/net cash and
cash equivalents of ~Rs3.7bn/~Rs3.3bn, respectively as of FY17-end (against Rs694mn dividend
paid out in FY17).Based on our FY18E dividend/share estimates (Rs9), dividend yield works out to
7%, which provides good downside stock protection. Sustained dividend payout record boosts
confidence on Sonata’s ability to generate cash flows for dividend, capex and making strategic
acquisitions for inorganic growth.
ff Sonata has not raised equity share capital since April 2001. On the other hand, gross debt-equity
ratio has ranged between 0.1x-0.4x over the past 4 years; thus, on a net basis Sonata is cash
positive. Interest coverage ratio has ranged between 7-23x, which reflects comfortable liquidity
and debt servicing capability. This drives further confidence in Sonata’s ability to generate healthy
cash flows and maintain a prudent capital structure.
ff We like Sonata’s differentiated business, high dividend yield, quality balance sheet, high RoE and
lack of equity dilution in 16 years. Given the company’s platform focus, investments made in IP and
S&M, decent cash generation, reasonable valuation and recent stock price correction from Rs220
to ~Rs160 levels, we believe there is room for upside for investors.
We assign BUY recommendation on Sonata Software with a Target Price of Rs177.
6
6
IT Sector
Institutional Equity Research
Results Preview | July 10,2017
Exhibit 2: Top-tier IT Companies – Sequential USD Revenue Growth Trend
Exhibit 3: Top-tier IT Companies – 1QFY18 USD Revenue Growth Estimates
(%, QoQ)
(%, QoQ)
6
10
7
4.0
4
3.1
4
2.5
1
2.1
2
(2)
0
(5)
4QFY15
2QFY16
4QFY16
2QFY17
(0.3)
4QFY17
(2)
TCS
Infosys
Wipro
HCLT
Tech Mahindra
TCS
Infosys
Wipro
Source: Respective companies, RSec Research
Source: RSec Research
Exhibit 4: Top-tier IT Companies – EBIT Margin Trend
Exhibit 5: Top-tier IT Companies – 1QFY18 EBIT Margin Estimates
(%)
(%)
30
25
24
20
18
15
12
10
24.2
HCLT
Tech Mahindra
24.1
18.5
19.4
8.9
5
6
4QFY15
2QFY16
TCS
Infosys
Source: Respective companies, RSec Research
4QFY16
Wipro
2QFY17
HCLT
4QFY17
Tech Mahindra
0
TCS
Infosys
Wipro
HCLT
Tech Mahindra
Source: RSec Research
7
7
IT Sector
Institutional Equity Research
Results Preview | July 10,2017
Exhibit 6: Mid-sized IT Companies – 1QFY18 USD Revenue Growth Estimates
Exhibit 7: Mid-sized IT Companies – 1QFY18 EBIT Margin Estimates
(%)
(%, QoQ)
5
30
4.6
27.3
24
4
2.8
3
18
2.7
2
12
1.6
1.0
1.0
1
16.0
10.4
9.6
9.3
6.4
6
0
0
Mindtree
Source: RSec Research
Cyient
Hexaware
KPIT
Persistent
eClerx
Mindtree
Cyient
Hexaware
KPIT
Persistent
eClerx
Source: RSec Research
8
8
IT Sector
Institutional Equity Research
Results Preview | July 10,2017
Exhibit 8: Summary Estimates (1QFY18)
Net Sales (US$ mn)
1QFY18E
QoQ (%)
EBIT Margin (%)
YoY (%)
1QFY18E
4QFY17
Adjusted EPS (Rs)
1QFY17
1QFY18E
4QFY17
1QFY17
Tata Consultancy Services
4,563
2.5
4.6
24.2
25.7
25.1
32.7
33.5
32.1
Infosys
2,623
2.1
4.9
24.1
24.6
24.1
15.7
15.8
15.0
Wipro
1,948
(0.3)
0.9
18.5
16.7
16.7
9.5
9.2
8.3
HCL Technologies
1,873
3.1
10.8
19.4
20.0
20.6
14.5
16.5
14.5
Tech Mahindra
1,176
4.0
14.1
8.9
8.2
12.0
7.4
6.6
8.4
Mindtree
205
4.6
2.8
10.4
8.9
11.2
7.0
5.8
7.3
Cyient
145
2.8
16.2
9.3
10.6
10.4
9.0
7.0
6.6
Hexaware Technologies
149
2.7
14.6
16.0
15.3
14.0
4.0
3.8
3.3
KPIT Technologies
130
1.0
8.2
6.4
7.3
8.3
2.1
2.7
2.8
Persistent Systems
111
1.6
5.7
9.6
12.5
10.2
9.0
10.5
9.2
eClerx Services
48
1.0
(3.6)
27.3
26.7
33.5
20.5
18.7
23.2
Majesco Limited
30
6.9
(7.6)
1.5
3.2
(169.0)
0.6
1.0
0.6
Sonata Software
31
2.5
7.8
5.5
5.8
6.2
4.1
3.8
3.5
13,032
2.2
5.9
20.3
20.7
20.9
Aggregate
Source: RSec Research
9
9
IT Sector
Institutional Equity Research
Results Preview | July 10,2017
Exhibit 9: Valuation Summary, Ratings of Coverage Universe
Company
CMP
(Rs)
Target
(Rs)
Reco
2,345
2,200
REDUCE
Infosys
948
1,040
Wipro
257
250
HCL Tech.*
840
963
Tech Mahindra
376
Mindtree
Cyient
P/E (x)
EV/EBITDA (x)
RoE (%)
FY17
FY18E
FY19E
FY17
FY18E
FY19E
FY17
FY18E
FY19E
17.5
16.6
15.0
15.3
14.1
12.3
33.0
29.6
28.2
BUY
15.1
14.9
13.4
10.4
9.9
8.7
22.0
20.4
21.4
HOLD
14.7
14.1
12.8
10.1
9.5
8.2
17.3
16.4
16.6
BUY
14.0
12.9
11.6
10.3
9.4
8.1
27.5
25.7
25.3
470
BUY
11.9
11.0
9.6
7.7
7.0
5.7
18.1
17.6
18.1
545
480
HOLD
21.9
19.3
15.9
12.5
10.8
8.9
16.8
17.6
19.6
528
565
BUY
17.3
14.2
11.9
10.7
9.1
7.3
17.1
18.9
20.3
Hexaware**
239
245
HOLD
18.5
17.5
15.7
12.5
11.5
10.1
28.9
26.5
25.1
KPIT Tech.
129
130
HOLD
10.8
10.9
9.2
6.2
4.9
3.9
16.1
14.2
14.9
Persistent
675
690
BUY
17.3
15.8
13.4
9.9
8.8
7.3
17.7
17.2
17.9
TCS
eClerx Services
1,299
1,315
REDUCE
15.0
16.3
14.6
11.0
11.2
9.3
30.7
24.5
23.3
Sonata Software
163
177
BUY
11.2
10.3
8.4
7.3
6.1
4.8
31.2
30.9
33.6
Majesco Limited
305
556
BUY
0.8
0.8
0.6
9.0
8.1
5.5
5.0
7.7
10.4
Source: RSec Research
Note: CMP as on July 06 , 2017
* Hexaware has a December-ending FY. Thus, FY16=CY15 and FY19=CY18..
** For Majesco, we have taken the Price to Sales multiple instead of P/E.
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IT Sector
Institutional Equity Research
Results Preview | July 10,2017
Rating Guides
Rating
BUY
HOLD
REDUCE
Expected absolute returns (%) over 12 months
>10%
-5% to 10%
>-5%
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