IT Sector Q1 preview: Revenue stabilisation, margin guidance to Gen AI impact and more

IT stocks have been in the limelight since last week. Heavyweight IT shares such as Infosys and TCS has rose in the range of 4% to 6% since 24 June. This recent rise in IT stocks comes ahead of Q1 earnings which are expected to be annouced in second week of July. Investors are keeping a close eye on IT sector amid expectation of strongest quartely earnings.

Market sentiment and performance

Another positive factor for IT companies is stable guidance. The big fear of guidance cuts seems to be alleviated. IT stocks had been underperformers through Q3 and Q4, experiencing EPS cuts and fall in prices. However, they have surged in the last month turning positive with around an average 11% increase. The NIFTY 50, serving as a barometer, has risen 4.4% and NIFTY IT index soared nearly 12.37% in the last month.

Outlook for FY25 and sector recovery

It is expected that the first quarter of FY25 will mark the bottom of sluggish revenue growth for the Indian IT services sector. According to the recent research report by Nomura, the IT sector shows signs of stabilisation in the revenue growth outlook for G2000 (annually ranking 2000) companies. While a strong recovery in discretionary demand may take a few quarters, it is unlikely to worsen further.

Interest rate cut cycle and a potential rise in decision-making by US corporates post-US elections in Nov 2024 could provide a boost to IT spending in the US. GenAI adoption is likely to gain steam in the next 12-18 months and could improve demand for cloud services and data standardisation. Overall, the expected revenue growth for large caps companies to be in the range of 3% in FY25 to 7.7% in FY26.

In FY25, revenue growth will be driven by large cost-saving projects, although these will have initial transition costs. Utilisation rates are expected to peak in the first half of FY25, leading to increased hiring in the second half. Besides, Indian IT companies will likely use strategies like delaying and reducing salary hikes and cutting subcontractor expenses to manage these pressures.

We can expect a mixed operating performance where leading IT stocks may report the strongest revenue, and the margins are likely to remain stable.

Management Guidance (Q3FY24 and Q4FY24 concall)

Tata Consultancy Services Ltd

TCS says pent-up demand is crucial for our customers' long-term growth, and we expect them to expand initiatives once macro risks decrease. TCS sees limited short-term growth due to weak discretionary demand and clients focusing on cost-saving projects.

The company is committed to a 26-28% margin, with a near-term focus on productivity, utilisation, realisation, subcontractor management, and long-term pricing. TCS is leading in Gen AI capabilities, with some client POCs moving to production, highlighting Gen AI's role in improving application development, maintenance, and deployment automation.

Infosys Ltd

Infosys reports that clients are prioritising cost optimization projects with quick returns on investment, showing no change in technology spending sentiment for FY25 compared to FY24 due to macroeconomic uncertainties.

The company is confident in its overall margin outlook, with initiatives in value-based selling, efficient workforce management, automation, and GenAI supporting this optimism. Key margin headwinds for FY25 include weak growth and salary hikes, while tailwinds include higher utilisation, reduced subcontracting expenses, and workforce optimization.

GenAI's interest is growing, with about 100,000 employees trained and projects spanning software engineering, process optimization, customer support, advisory services, and sales and marketing.

HCL Technologies LTD

For FY25, HCL Technologies is confident of strong exit momentum this year. FY25E will be a year of consolidation on both demand and supply sides, with soft growth in 1H25E and improvement in 2H25E. The current environment does not favour increasing margins, but there is some progress, albeit slow.

The company aims for a margin band of 19-20%, though it will take time due to low growth. Surround level spends (cloud migration, Gen-AI stacks, data modernization, security, privacy) are expected to be 25x of every dollar spent on GenAI.

HCLT has a Gen-AI lab in London showcasing five or six use cases and has won 30 deals in GenAI projects. There is significant interest in AI and GenAI, with a strong pipeline built through successful POCs and ongoing training efforts in GenAI.

Wipro Ltd

The management of Wipro Ltd says that the market has remained stable with slight increases in discretionary spending. Wipro notes macro uncertainty but sees a major tech shift with clients keen on AI. Margins are expected to stay range-bound but may improve with ongoing transformation and efficiency efforts.

Key drivers include productivity, employee skilling, and cost optimization. Revenue growth is needed for significant margin improvement. AI is becoming crucial, with 210,000 employees trained. Wipro launched the Enterprise AI-Ready Platform with IBM to help clients create integrated AI environments.

LTI Mindtree Ltd

LTIM expects growth from 1QFY25E due to scale, expanded capability, and stronger partnerships. Although margins are being optimised, the 17-18% exit margin target will be delayed by a few quarters due to weaker revenue. The company continues to aim for a 17-18% EBIT margin despite near-term challenges. A new service line, Enterprise AI, aims to integrate GenAI into all service lines and four customer priority areas, training over 10,000 employees on GenAI. Strategic partnerships with Microsoft, AWS, Oracle, Snowflake, and NVIDIA, along with initiatives like the GenAI and Digital Hub in Athens and facilities in Poland and Mumbai, position the company well for future growth.

Tech Mahindra

The market environment is slightly better than six months ago, but it's too early to call it a recovery. Tech Mahindra is focusing on increasing sales investments, client focus, and reducing tail accounts to achieve industry-leading growth in three years. The current EBIT is 7%, and from Q4, excluding the annual impairment exercise, it should be seen as a bottom.

Project Fortius is expected to drive most of the margin expansion, with estimated savings of about USD 250 million per year. By FY27, the company aims for above-average peer growth and a 15% EBIT margin. There has been significant progress in GenAI initiatives, with active client conversations and early-stage experiments moving to production pilots, particularly in Conversational AI and Document AI. The company is investing in AI, aiming to move Gen AI to production this year and infuse AI in application development, IT operations, and BPS.

FY25 marks a pivotal period for the Indian IT sector. It is poised for growth with stable revenue forecasts and strategic advancements in GenAI, despite lingering economic uncertainties.