IT – Q1FY14 Preview

The IT sector has been facing a downturn because of global macroeconomic factors, spending cuts and delayed decision making. Moreover, secular changes in technological trends have been causing a disruption in the way these companies have been functioning. All these have resulted in a disappointing Q4FY13 for the IT sector.

The sequential growth in revenues of the top four companies (Cognizant, TCS, Infosys and Wipro) was 2.18% in dollar terms and 2.78% in constant currency terms. Revenue growth was moderate, but the operating margin saw a decline of 1.9%. While this was for the top 4 companies, the overall sector performance was flat. Revenue growth stood at 0.12% and growth in profitability at 0.71%. Will Q1FY14 be a better quarter?

The sector has been rather dynamic because of the recent developments that could have a large impact on the profitability of the sector. This has resulted in increased volatility in the stock price movement of IT companies in Q1FY14 so far. Although some of these factors would show their impact in different time periods, Q1FY14 looks like it will be a better quarter than Q4FY13.

Q1 and Q2 are cyclically strong quarters. Spending budgets see some kicking in and revenue growth is usually stronger in these quarters. This would show in the form of improved topline for IT companies.

Geographically, there has been an improvement in the US economy and it is likely to show in the results. Europe has been a growth driver for IT companies as the region continues to spend heavily on technology transformation despite economic turbulence.

Growth from areas like social, mobility, analytics and cloud are further likely to boost growth for these companies. These technologies have been termed as disruptive and have seen high growth in the recent past and are likely to compensate for the slowdown the sector faces because of subdued demand for traditional application development and maintenance.

Profitability of the sector is also likely to improve. The recent fall in the INR is likely to be a significant contributor to the boost in profitability.

Recently, the passage of the overhauled immigration bill in the US senate increased the likelihood of the implementation of new rules. These would imply various measures that would hurt the profitability of the sector and require drastic changes in the operational model of these companies. However, the timeline towards implementation is long-term and the bill is expected to undergo various changes in the process. The implications of this would be long-term and would not affect the financial performance of these companies in Q1FY14.

Overall, the prospects of Q1FY14 seem better and performance is likely to be positive for IT companies. However, it is important to remember that their performance has become more specific to individual companies than the sector performance. The strategy of capturing changing trends and focusing on high-growth areas have been determinants of performance.

Considering this, we are bullish on the performance of TCS, HCL Tech, Tech Mahindra, KPIT Cummins and Persistent Systems over other IT companies.