IT sector Q1FY24 preview: No positive surprises seen; Infosys may tighten revenue guidance

IT sector Q1 preview: Analysts, in unison, are of the view that most IT services companies will report a weak set of numbers for the quarter ended June 30, 2023 (Q1FY24). Q1 happens to be the strongest quarter for the IT sector; however, this time it’s going to be different given the challenging macro conditions. A soft discretionary spending environment, combined with the pullback of projects in financial services and telecom, is expected to impact the revenue growth of the companies. This, coupled with project ramp downs and a lower conversion of total contract value (TCV) to annual contract value (ACV), will impact near-term growth, they add.

Besides, the EBIT margins of the companies are expected to remain under pressure, and there is a possibility that Infosys may tighten its revenue guidance.

Here’s a look at the key points in a little more detail:

Macro-economic conditions

A slowing macro is feeding its way into the performance of clients of IT companies and, consequently, spending. The pullback in discretionary spending and programme cancellations will lead to a weak FY2024, notes Kotak Institutional Equities.

"The list of challenged verticals has increased, with heightened impact in financial services, telecom, and hi-tech. We do not expect a recovery in discretionary spending in CY2023. However, what has changed is the growing pipeline of large and mega-deals. Some IT companies have made deals to this effect. Pickup in large deal momentum is critical for 2H growth and laying the foundation for FY2025 growth," they add.

Margin Outlook

"Most of the large caps are expected to report a flat to -118 bps decline in margins due to wage hikes and the absence of operating leverage. However, among mid-caps, most of them will report a +60 bps to +85 bps improvement in margins. The only exception is Coforge (-238 bps) due to wage hikes and visa costs," wrote Devang Bhatt and Dhawal Doshi, research analysts at IDBI Capital, in their Q1 earnings preview note.

Nirmal Bang Securities said that while pyramid, cross-currency, higher utilisation, easing of attrition and backfilling costs, lower sub-subcontracting costs, and a lower quantum of salary hikes, among others, will be tailwinds, a lack of operating leverage, rebadging, higher travel and facilities costs, transition costs from cost optimisation projects, and likely pricing pressure will act as headwinds.

Rebadging means the acquisition/legal transfer of ownership of the relevant IT staffing resources from the originating, or incumbent company over to the rebadging entity.

Revenue Outlook

The revenue of Tier-1 companies is expected to remain muted on account of weak macroeconomic conditions, cuts in discretionary spending, and project delays. "We expect revenue growth of Tier-1 companies to be in the range of -2.5 per cent to +0.9 per cent QoQ in constant currency terms (CC). Revenues of Tier-II players (excluding L&T Tech Services) are expected to fall within a wider range of -1.2 per cent to +3.3 per cent QoQ in CC terms. LTTS is expected to grow 12.2 per cent QoQ in CC terms, primarily attributable to the Smart World & Communication (SWC) acquisition," said Motilal Oswal Securities in an earnings preview report.

Guidance Outlook

In terms of guidance," we expect Infosys to narrow its top-end direction to 4-6 per cent from 4–7 per cent. We expect Wipro to guide 0 to -1 per cent QoQ revenue guidance for Q2FY24E," said IDBI Capital.

Kotak Institutional Equities also expects Infosys to tighten its revenue growth guidance range to 4-6 per cent from 4-7 per cent earlier. Further, HCL Tech will likely retain 6–8 per cent revenue growth guidance, it adds. Additionally, the brokerage expects Infosys and HCLT to deliver 5 per cent and 6.3 per cent revenue growth for FY2024E, respectively.

"We expect both companies to retain margin guidance bands. Wipro’s quarterly revenue outlook for the September 2023 quarter will be muted at (-)1% to 1% range," it said further.

Deal wins

With the current macro, the pushing back of discretionary spending, and project delays and cancellations, Nirmal Bang Securities believes that almost all companies will see a QoQ and YoY decline in deal TCV in 1QFY24. Another issue lies with the conversion of TCV to revenue and the quantum of leakages from the signed-up TCV of the prior quarters.

"Leakage has been at higher than normal levels, as we gather from our discussions with companies, though numbers have been difficult to get," the brokerage wrote.

Revenue leakage refers to money that has been earned but not collected, generally because of a lack of awareness on the part of the business.

Other key things to watch out for

Net hiring, commentary on salary increases in FY24, the extent of deterioration in demand in sub/verticals beyond BFS, Retail, Hi-Tech, and Telecom, an update on generative AI and any projects related to it, strength in Europe, and if it can continue to hold up as was the case throughout FY23, are some of the key monitorable. These aside, commentary on vendor consolidation and cost optimisation projects and their implications for onsite staff will also be closely tracked.

Nifty IT vs. Nifty50 performance

The Nifty IT index has risen 6 per cent in the past year (from June 30, 2022-June 30, 2023), Trendlyne data show. In comparison, the Nifty50 index has rallied 21.6 per cent during the window.