IT Services Q3 Results Preview - Furloughs, A Headwind Over And Above Adverse Macros: Motilal Oswal

Motilal Oswal Report

Higher furloughs likely to dampen revenue growth further-

The weakness in Information Technology services demand has been further intensified by higher-thanexpected furloughs in Q3 FY24. The seasonality is likely to hurt revenue growth and margin performances of both tier-1 and tier-2 IT companies. The industry has not witnessed any meaningful change in spending patterns, as discretionary spending continues to take a pause across enterprises. Although sentiment has improved, it has not yet been reflected in actions.

Our IT services coverage universe should report a median revenue growth of 0.7% QoQ/2.5% YoY in Q3 FY24. The adverse movement of major currencies (Euro/Great British Pound: -1.2%/-2.0%) is anticipated to further slow down the reported growth. The muted revenue growth and revised compensation (selective names) in Q3 are less likely to aid margin improvement. However, the weakening Rs (~70 basis points against United States dollar) should act as a support. We estimate a flat USD revenue YoY, while Rs Ebit/Rs profit after tax YoY will decline 4.0%/2.0% in Q3 FY24.

The combination of adverse macros and higher-than-expected number of furloughs has extended the timelines for deal closures and executions across companies, leading to slower revenue conversion in the third quarter.

We expect the deal total contract values to moderate from the Q2 high base coupled with furloughs impact in Q3; otherwise, the earlier theme of reprioritizing cost optimization and driving efficiency remains intact. We expect the collective deal TCV (tier1 + tier 2) growth to stay in line or moderate YoY.

The slowdown across major verticals and key geographies should persist, with BFSI, Retail, Hi-Tech, and Communications likely to experience higher-thananticipated furloughs in 3Q. Although the pace of growth deceleration for the major verticals has slowed in 2Q FY24 (BFSI/Retail median declines 0.4%/0.3% QoQ), the same has not yet gained momentum to support the topline.

We expect BFS and Hi-Tech to be adversely impacted in Q3 FY24, while the other verticals should deliver muted performance. On the other hand, there is no sign of demand recovery in the key geographies (United States and Europe), although the situation has not deteriorated materially. The majority of the clients are exercising caution and reprioritizing their spending.

As Q3 furloughs are higher than anticipated at the beginning of FY24, we expect the selective tier-2 companies (Coforge Ltd., Cyient Ltd.) to revise their revenue guidance downward. Despite this, we expect the companies to maintain and achieve margins within the guided band by implementing rigorous cost-cutting measures.

We expect revenue growth of tier-I companies to be in the range of -2.7% to + 4.5% QoQ in constant currency terms. Revenue of tier-II players are expected to grow to the tune of -4.4% to + 3.0% QoQ in CC terms.

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