 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.

To read the full report: IT SERVICES