Q2 results will be a mixed bag; Murthy view key for IT stocks

As the results season kicks off, all eyes are on the sectors which have a large overseas play, since the decline of the rupee vis–vis the dollar over the past few months will have a telling effect on the fortunes of companies depending on which sectors they belong to. By most accounts, the IT and pharma sectors and select auto companies are expected to reap the benefits of a falling rupee, while sectors with large domestic exposure are likely to be impacted by the slowdown at home.

For now, the attention of the markets and analysts is focused on tech bellwether Infosys, which will declare its Q2 results on 11 October. What will be of utmost importance for the markets will be the analysis put forward by Infosys chairman NR Narayana Murthy and his FY14 annual guidance and growth strategy for the company, going forward. This, analysts believe, could well play a key role in how the markets view IT stocks from here on. The BSE IT Index, it may be mentioned, has outperformed the broader market in the second quarter, as it became clear that the falling rupee would mean good times for IT companies and the signs of an uptick in IT spends would also mean good results by tech companies in the quarter.

Says HDFC Securities in a preview of the Q2 results: “With Narayana Murthy back, commentary from the management on the future growth strategy and on the sector outlook would hold a lot of significance. At present, the expectations of better than expected Q2 results are very high. Hence, any disappointment could result in a correction across the entire IT pack.” The broking firm adds that Murthy’s views on deal pipeline, growth revival and management attrition would be important.

The broking firm says it expects most IT companies to report healthy quarter on quarter (Q-o-Q) USD revenue growth in Q2FY14, led by some improvement in demand scenario. Tier-I IT services companies are expected to report a USD revenue growth of 2.5-6 percent Q-o-Q with TCS likely to lead the pack, the report says. “Wipro is likely to grow at the lower end. Growth of most of the companies is likely to be volume driven. Q2 is traditionally a strong quarter for the sector, which should enable the companies to report healthy volume growth. Pricing is expected to remain more or less stable. Cross currency headwinds are likely to impact the USD revenues of Top 4 IT companies by around 50-70 bps. However, in INR terms, the revenue growth is likely to be better on the back of 11 percent average depreciation in rupee during the quarter on q-o-q basis,” it says.

Margins of most of the IT players are likely to improve owing to the sharp rupee depreciation during the quarter. Every 1 percent depreciation in the rupee causes a 25-50 bps improvement in margins. But wage hikes, it is felt, will limit expansion.

HDFC Securities, however, warns that since 28 August, the rupee has appreciated sharply by around 9.8 percent against the dollar and is expected to stabilize in the third quarter following the steps taken by the Reserve Bank of India (RBI). This could cause concern on the margins in the third quarter, the broking firm says.

Among other sectors, healthcare and metals are also expected to come up with a fairly good set of numbers, owing to the dollar impact. The auto sector could also be a good performer, with about 11 percent year on year growth, well above the aggregate, reckons broking firm Motilal Oswal Securities. This is once again thanks to dollar-denominated sales in some quarters and strong showing by the Jaguar Land Rover part of Tata Motors.

An IDFC Securities report, on the other hand, pegs Sensex revenue growth at 11.3 percent year on year, against 4.9 percent in Q1FY14, as sharp depreciation of the rupee boosted revenues for IT and pharma. The commodities companies topline would be subdued at 3.1 percent y-o-y, highlighting the weak domestic demand environment. Higher topline growth in non-commodities (19 percent) would be led by growth in IT (30 percent), pharmaceuticals (23 percent), automobiles (22.4 percent yoy, led by 34 percent yoy growth in Tata Motors, on back of strong JLR sales growth in Q2FY14, IDFC Securities adds.

The EBITDA margins of Sensex companies is expected to improve by about 40bp year on year to 19.3 percent. Among commodities, earnings expansion will be led by Metals (70bp yoy), mainly the Sesa-Sterlite combine. Among non-commodities, margin expansion is expected in consumer goods (up about 100bp yoy), Telecom (200bp yoy), auto (190 bp yoy) while margins are expected to contract sharply in financials (down 680 bp), IDFC Securities says.

On the oil and gas sector, broking firm IIFL expects oil marketing companies to report a weak set of numbers on the back of nil provisioning of under recoveries from the government. The decline in gross refining margins will have further negative impact on profitability, it says.

On the telecom side, it says the second quarter results for frontline telcos is likely to be impacted by seasonality as the quarter is typically the weakest in terms of traffic trends.