Are you reading the Q3FY21 report card of IT companies the right way?

The result season has kicked off in style. Indian IT majors such as TCS, Infosys and Wipro have declared their Q3FY21 results.

Going by quarterly numbers and the subsequent management commentary, it seems that technology is perceived as the only dependable solution to most of the problems faced by corporates across the globe. So, be it clocking higher growth, attaining greater efficiency or ensuring higher security, businesses—large and small alike—are spending generously on technology.

Financial performance…

(Source: company records)

If you remember, post Q2FY21 results, Rajesh Gopinathan—MD & CEO of TCS had stated that the global IT space had been undergoing a multi-year technology spending cycle driven by cloud adoption. The company’s total new deal wins of $6.8 billion in Q3FY21 and its potential pipeline suggest that the upswing in the tech-spending cycle has begun to get reflected in the numbers already. The management of TCS remains confident that this is going to remain a secular growth driver for the company over the next 3-5 years.

Operating profit margin of TCS improved over 100 bps (basis point) on a Y-o-Y basis. When measured on a constant currency basis, continental Europe and India business grew 3.6% and 4.1%, respectively, Y-o-Y.

On the other hand, Infosys fired on all cylinders in Q3FY21.  The company struck two mega deals—one with Daimler, which the management has been calling perhaps the largest-ever deal in the history of the Indian IT industry and the other with Vanguard.

Digital revenue of Infosys grew 31% on a Y-o-Y  basis and now it accounts for more than 50% of the company’s top line. Infosys signed new deals worth USD 7.1 billion in Q3FY21 thereby outrunning even TCS. BFSI, high-tech and life sciences divisions delivered stellar performance in the quarter gone by.

Tata ELXSI—another Tata Group company focused IT business—surprised investors with its ecstatic performance in the December quarter. Embedded Product Design (EPD) is the mainstay of the company’s business which accounts for 88% of the revenue. Industrial Design and Visualization has a 9% share in the revenue and the remaining tiny contribution comes from the System Integration and Support (SIS) stream.

The company surpassed Rs 100 crore quarterly profits for the first time and its operating profit margin jumped 800 bps Y-o-Y—from 22.2% in Q3FY20 to 30.1% in Q3FY21.

Healthcare and Medical Devices business reported an impressive 34% Y-o-Y rise. It now contributes 10.4% to the company’s top line. Contribution of time-and-material-based contracts improved sharply from 49.2% in Q3FY20 to 56.1% in Q3FY21. This reflects and reinforces the confidence and ability of the company to complete projects in a timely manner.  

Following the footsteps of its peers, Wipro also struck the largest deal (in the company’s history) in Continental Europe with Metro AG, a global company operating in the food distribution services industry. According to the company’s estimates, the deal will fetch Wipro USD 700 million in the first phase of 5 years and a probable 4-year extension may take the total deal value to USD 1 billion.

Wipro’s operating profit margin improved 330 bps Y-o-Y, from 18.4% to 21.7%. However, it experienced a 2% fall in the revenue on a constant currency basis. The company has guided a moderate increase in revenues of 1.5% to 3.5% Quarter-on-Quarter (Q-o-Q) in Q4FY21.

Other important highlights

  • The digital transformation agenda of corporates has been driving in top gear with IT spends rising across industries. New investments are primarily targeted at making businesses more integrated and future-ready, which also includes bringing about substantial tech-driven changes in the business models.
  • Besides cost-efficiencies, better user experience and new product developments, corporations have been deploying new-age technologies to ensure regulatory initiatives and various ESG compliances.   
  • Considering the nature of the business, monitoring attrition rate of the IT companies is crucial. All four companies have reported a substantial fall in the voluntary attrition on a Y-o-Y basis. In fact, the Tata Group’s IT businesses have witnessed an attrition of only 6%-7%, which is better than its peers. Low attrition suggests that the job market may not have picked up yet, even in the IT space, although the revenues of large-sized companies have gone up substantially.
  • The percentage of employees working from home is as high as 98%. Now that the offices are likely to open gradually and business travel could also resume, at least some of the cost savings are likely to unwind. Now it remains crucial to see how companies manage their costs through automation, an optimal shore-off shore mix and sub-contracting policies.

Stock market performance of IT companies

As you must have seen, several IT stocks have already hit their all-time high and the valuations have skyrocketed, breaching their 10-year averages. Tata ELXSI has rallied more than 50% in the last one month. There aren’t many comparable businesses in the Indian IT sector. However, a close competitor of Tata ELXSI, L&T Technology Services, which is also engaged in Engineering and R&D, has also rallied ~50% in the last one month.

 Based on Bloomberg 1-year forward earnings estimates
(Source: Ventura research)

Based on Bloomberg 1-year forward earnings estimates
(Source: Ventura research)

Based on Bloomberg 1-year forward earnings estimates
(Source: Ventura research)

Based on Bloomberg 1-year forward earnings estimates
(Source: Ventura research)

Although the likes of Infosys and Wipro have witnessed a noticeable drop in their stock prices post Q3 results, investors seem to be expecting the better performance to continue. High valuations, rising prices and higher earnings estimates suggest that IT stocks will now face performance pressure, going forward. Historically, markets have punished expensive stocks which disappointed on earnings.

Doesn’t that mean you should sell-off all your IT holdings? No! Perhaps, it’s the time to get rid of excesses—excess equity exposure, excess exposure to a particular sector/theme or a stock. In the process, you may want to review your portfolio.  

You may also like to read: Betting on auto stocks? Evaluate these risks!

 

Disclaimer:

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

 

 

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