In the latest performance review for the June quarter (Q1FY25), IT services companies within the Motilal Oswal Financial Services (MOFSL) Universe have surpassed expectations, demonstrating a median revenue growth of 1.2% QoQ in constant currency (CC). This reflects a strong performance in a sector that is gradually shifting focus due to evolving market conditions and client spending patterns.

Sector Dynamics and Shifts

According to MOFSL, there has been a noticeable shift among IT firms from cost-reduction deals to "high-priority" transformation deals. This shift is largely attributed to a mild recovery in discretionary spending among BFSI (Banking, Financial Services, and Insurance) clients. Despite this positive change, overall pressure on discretionary spending remains a concern. The brokerage house believes that the sector might be experiencing a turning point, as clients start to reinvest savings from cost-reduction measures to tackle technological debt.

Top Picks in the Sector

With most IT firms having reported their earnings for the June quarter, MOFSL has identified its top picks within the sector. The brokerage favors HCL Tech and LTI Mindtree among large-cap companies, and Persistent Systems in the mid-cap segment.

HCL Tech has demonstrated effective management of seasonality and is anticipated to deliver a robust second half of FY25. The company’s free cash flow (FCF) metrics have significantly improved, aligning with those of industry leaders like TCS and Infosys. This improvement justifies HCL Tech's premium valuation, according to MOFSL.

LTI Mindtree is well-positioned for growth in areas such as data engineering and ERP modernization, enabling it to capitalize on pre-GenAI expenditures. MOFSL expects LTI Mindtree to outperform its large-cap peers, projecting a low double-digit constant currency growth for FY26.

Persistent Systems stands out for its strong earnings growth and strategic shift towards platform-based services for GenAI spending. MOFSL projects a 17% dollar revenue CAGR and an over 25% EPS CAGR, supporting its premium valuation multiple.

Quarterly Performance Insights

The review reveals varied performance across the IT sector:

Tier-1 IT companies exhibited a healthy median revenue growth of 1.5% QoQ in constant currency, while Tier-2 companies reported a lower growth rate of 0.8% QoQ CC. Excluding Cyient, Tier-2 companies achieved an inline growth rate of 1.6% QoQ CC.

Cyient and Wipro were notable underperformers, with Cyient experiencing a -5.0% QoQ CC decline and Wipro showing a -1.0% QoQ CC decline. In terms of margins, Tier-1 companies saw a slight contraction of 20 basis points (bp) QoQ, while Tier-2 companies faced a more significant contraction of approximately 150 bp QoQ, primarily due to Cyient’s 250 bp QoQ margin decline.

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The Total Contract Value (TCV) has returned to normal run-rate levels, with a 23% QoQ decrease for Tier-1 companies and a 20% QoQ decline for Tier-2 companies. Infosys stood out with strong deal wins, securing 34 large deals with a TCV of $4.1 billion in Q1, 57.6% of which were net new deals.

EPS Upgrades and Downgrades

In terms of EPS adjustments:

Infosys saw 3% upgrades for FY25E and 6% upgrades for FY26E.

L&T Tech experienced 5% downgrades for FY24E and 1% downgrades for FY25E.

Cyient’s DET business faced significant EPS reductions of 17% for FY24E and 6% for FY25E.

Zen Technologies received 6% upgrades for FY24E and 1% for FY25E.

Overall, MOFSL’s review indicates a sector in transition, with certain companies showing strong performance and growth potential amid evolving market dynamics. The focus on transformation deals and strategic investments highlights the sector’s resilience and adaptability in a changing landscape.

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