Remain constructive: Given some sector rotation ahead of India elections, INR appreciation and some cautious management comments on the near term, the sector has underperformed 10% over the past month (flat YTD—year to date). However, we believe near-term concerns are largely company-specific/seasonal and most data points still suggest robust demand over the medium term. Prefer Wipro/ HCL Technologies in the sector.
Q4 to be in line with seasonal trends: We expect stable revenue growth quarter-on-quarter (2.5-3% for Tier-1 companies, ex-Infosys) including a slight cross currency tailwind. Margins are likely to trend down (including some impact of wage hikes in HCLT and Tech Mahindra and currency). Companies could also see some fx translation losses given sharp INR appreciation towards end of the quarter.
Watch out for Q1 acceleration: Given most data points still suggest a robust demand environment in the medium term, investors would watch for reassuring commentary around deal wins, discretionary spends and indications of acceleration in Q1. Other key points to monitor–(i) quantum/timing of wage hikes planned for the year, (ii) indications of any pick-up in hiring, though companies are increasingly opting for just-in-time hiring given changes in the business models.
Company specific details—(i) Infosys: expect flattish revenues/margins q-o-q. (ii) Expect TCS/HCLT to report steady 2.5 to 3% growth with a slight downward bias in margins (investments and some impact of wage hikes in HCLT). (iii) Wipro is likely to converge with peers and see some margin improvement. (iv) TechM - expected to see good growth given recent deal wins, but margins likely to see headwinds (wage hikes, discontinuation of revenues from restructured contracts).
Infosys guidance: With some negative commentary around the near term, investor focus will now be on the FY15 guidance. We believe revenue growth guidance of 6-8% y-o-y could be a starting point, given commentary on near-term headwinds, potential conservatism baked in the guidance and relatively higher exposure to discretionary spends.
Change in estimates: We have recently trimmed estimates, largely due to revised foreign currency assumptions (now at R59.5/$ vs. 61.5 earlier) and some operational changes in revenues/margins; our target prices are now based on September 15e earnings (earlier March 15e).
Valuations offer healthy upsides: BSE Teck now trades at 14-15x one-year forward, at 15% discount to historical mean and at par with the Sensex. Given the robust demand trends, we believe risk reward remains favourable here.