>IT SERVICES: Earnings Expectations and Ownership – A Closer Look

 Earnings beat/upgrades to drive stock prices — Given current valuations, EPS
beat/upgrades remain the key catalyst for the sector, in our view. For example,
post 1Q results, TCS was the only stock that witnessed meaningful operational
upgrades – after which, TCS outperformed its peers. In that context, we take a
closer look at expectations as they can limit or result in surprises/upgrades.
 Expectations for Infosys are the highest; Wipro the lowest — Our analysis (Fig. 1)
highlights that consensus (IBES) expectations for Infosys are the highest – implied
EBITDA CQGR over next three quarters is ~10%. The same number for TCS and
HCLT is 4.1% and 4.5%. Wipro stands out – expectations are lowest at ~1.2%
CQGR over next three quarters (we are slightly ahead).

 What does history suggest? — Our analysis (Fig. 2) suggests that Infosys has on an
average delivered ~8% CQGR (2Q to 4Q) over the last 5 years. While that does not
rule out the possibility of positive surprise, it is a limiting factor. Also, 2Q is strong
but 3Q/4Q are seasonally weak quarters. Wipro, on the other hand, has delivered
an ~8% CQGR (2Q to 4Q) over the last 5 years – good likelihood of EPS upgrades,
we would argue.

 Is Indian IT under-owned? — Yes, it is – FIIs (300bps), DMFs (~600bps) and
Insurance (~700bps) are all underweight. However, the key question is: whether it
is a technical under-ownership? The surprising part is that over the last 5
quarters, the sector has outperformed but its relative weight (vs index) has gone
down. In MSCI India, Infosys is ~11% while in Nifty it is ~8.3% (and ~10% in
Sensex). With most funds unlikely to have such a big exposure to a single stock,
under-ownership may remain and may not be a big supporting factor.

 Remain Neutral on the sector; Buy HCLT/Wipro — Given recent macro concerns
and high expectations/valuations, it is difficult to see meaningful upside. In the
expectation context, Wipro looks a likely candidate for EPS surprises, has
underperformed (~7% vs. BSEIT YTD) and trades at ~15-20% discount to TCS
and Infosys. HCLT/Wipro are our top picks in Indian the IT services space.

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