Mid-cap IT firms set for profit squeeze in Q4

 The January-March quarter is a seasonally weak one, as clients generally finalise their budgets for the next fiscal during this period, leading to a spurt in spending in the first two quarters of the upcoming fiscal year.

“We remain cautious on mid-cap companies, which should underperform on growth and margins,” JM Financial said in a report. A Reuters poll of brokerages estimates profits at Patni Computer Systems, MphasiS, MindTree and Infotech Enterprises to show a double-digit decline, while the downtrend is seen continuing at Mastek.

However, profits at HCL Technologies, Rolta and KPIT Cummins are expected to rise in double digits, while Hexaware is likely to outshine its peers with a three-fold rise in its Jan-March profit.

“We have a clear preference towards Hexaware. With robust top-line growth, margins should also increase by about 100 bps,” Anand Rathi Securities analyst Naushil Shah said. “It has about 29-30 per cent of its revenue coming from enterprise application. Hexaware is seeing very good traction in that particular vertical.”

Revenue jump

Analysts also expect KPIT Cummins, which posted an 18 percent jump in revenue in Oct-Dec, to grow faster as compared with its peers due to strength in the manufacturing sector. However, MindTree and MphasiS could disappoint.

MindTree’s performance is expected to be under pressure after the recent restructuring to convert its handsets and 4G long-term evolution IPR business into a platform for providing research and development services to network infrastructure and handset firms.

“We are in a wait-and-watch mode for MindTree,” Vimal Gohil, analyst at Asit C. Mehta Investment Intermediates, said. "The business model looks to be quite lean now after the restructuring, which is a good thing. We will just have to see how things pan out to be.” MphasiS, which has been trying to reduce dependence on Hewlett-Packard, its parent and largest client, could see profits falling over 18 per cent.

HP owns 60.53 per cent of MphasiS, according to Reuters data, and also accounts for about 70 per cent of its revenue and the firm has said it is not very optimistic on HP channel revenue. Earlier, industry bellwether Infosys Technologies Ltd, India's No. 2 software services exporter, posted a lower-than-expected quarterly profit, hurt by higher costs, and forecast tepid sales growth for FY12.

Margins to be stable

IT companies are largely expected to see stable margins during the quarter due to a slight depreciation in the rupee against the dollar, making up for a dip in utilisation rates. The rupee weakened about half a percentage point against the dollar during January-March.

“EBIDTA margin for all Indian IT vendors is expected to improve marginally, partially due to rupee depreciation and due to increase in utilisation in certain cases,” PINC Research said. “The depreciation will positively impact operating margin by about 30-40 basis points quarter on quarter.” Indian software companies, which get most of their earnings in foreign currency, hedge some of the risk, but with a chunk of their costs being in rupees, currency appreciation tends to squeeze margins. Attrition during the quarter would be lower as most employees will await their annual appraisals and promotions.

 Analysts will, however, await management commentary about hiring plans and wage hikes, but most expect positive comments on pricing in FY12. “As global IT spending is expected to increase by 5.6 percent in 2011 to $3.6 trillion, we remain bullish on prospects of Indian IT Services industry,” Jaypee Research said in a report.