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Better Days Ahead

Improving US economy signals good times for the technology sector with Tier-1 companies leading from the front

The tech sector has been a consistent performer for some time now and did not fail the market's expectations from it. Revenue growth from the US - the largest revenue source for Indian IT sector - came in higher than the previous two quarters. Revenue growth from the rest of the world (excluding Europe), saw better than expected 10 per cent (y-o-y) growth - the second consecutive quarter of such growth.

Tier-1 tech companies reported a revenue growth of 4 per cent (q-o-q). An improved economic outlook in the US has positively impacted demand. The only geography that saw weakness was the euro that pulled down growth. Key companies that struggled with growth in Europe were TCS and HCL Tech. Verticals reported to be doing particularly well include manufacturing, and energy and utilities that saw robust growth of eight per cent and seven per cent (q-o-q) respectively, for tier 1 companies.

On aggregate, the industry reported revenue growth of close to 16 per cent (y-o-y). Operating profit grew by 11 per cent. Aggregate EBITDA margins declined from 24.4 per cent to 21 per cent. The top 4 companies of the sector led from the front with higher-the-industry revenue and operating profit growth of 18.65 per cent and 31.4 per cent, respectively. Margin-wise, the top 4 were ahead too, with aggregate margins of close to 30 per cent.

An area of concern is the slowdown in the BFSI and the retail segments. Combined, these two verticals are the largest revenue sources for most domestic technology companies.

Outlook
TCS, Infosys and Wipro have seen utilisations at three-year peak levels so utilisations here are unlikely to significantly improve in the immediate future. According to Nomura, tier-1 companies should report earnings per share growth of around 15 per cent over FY15-17. The fall in the rupee should bring in some joy. The technology sector trades at 18.5 times its earnings. The top four companies trade at a higher 19 times earnings.

Star performer of the sector
HCL Tech
HCL Tech has been doing well. It has shown a remarkable ability to win bids and improve the bottom line. Earnings per share growth for the last 12 months reported at 48 per cent - the highest among the top-4. Its IMS vertical that brings in a third (35 per cent) of topline is gearing up for rebids worth an estimated $160 billion in the next three years. An improving margin profile should help the company get into the big league.

Tier-1 tech companies outperformed industry growth and earnings performance

Company NameSales Growth YOY PAT Growth YoYTTM EPS (G) YoYTTM Ebitda margin (%)D/EROCE
(%)
TCS0.24220.37420.374233.09 (30.72)0.0157.58
Infosys0.1530.24150.241531.76 (28.61)035.72
Wipro0.15450.25560.254327.13 (24.54)0.1629.89
HCL Technologies0.21860.49350.486127.06 (23.62)0.0547.27
Tech Mahindra0.63570.61320.592220.65 (23.64)0.0447.64