The December quarter earnings season for India's IT sector is underway, with investor focus on large-cap companies including TCS, HCL Tech, and LTIMindtree. The Street is preparing for a seasonally softer quarter on revenues while closely monitoring deal momentum, margins, and the evolving AI narrative.

TCS Performance Outlook

TCS is expected to deliver steady rather than spectacular results for the December quarter. The company is likely to report flat to marginally positive revenue growth, reflecting the broader demand environment and typical December quarter furloughs.

According to Sushovan Nayak from Anand Rathi Institutional, "this will be slightly flat to marginally positive revenues, 0.5% to 0.6% CC growth is what we are expecting, and margins to be marginally impacted by the wage hikes because last quarter it was just one month of wage hike and this quarter it will be for the complete quarter."

Deal Momentum and Client Spending Patterns

The second half of the fiscal year typically witnesses higher deal renewals and new client decision-making. Nayak noted, "Generally, if you look at Q3 and Q4, that is when most of the deals start getting renewed and most of the customers take decisions as far as new deals are concerned. So, you will see seasonally strong TCVs as far as TCS and most of the other large-cap IT pack is concerned."

Discretionary spending recovery remains selective rather than broad-based, with visibility primarily in specific sectors:

• High-tech sector: Showing signs of recovery
• BFSI segment: Experiencing selective spending increases
• TCS BSNL account: Expected to drive primary ramp-ups

HCL Tech's Outperformance Trajectory

HCL Tech continues to distinguish itself as an outperformer within the large-cap IT space. The company had previously indicated certain deals were right-shifted, setting up a stronger second half performance.

"HCL Tech has always grown better than the sector, and we believe that this will continue to be the case… even this quarter," Nayak observed. Despite near-term margin headwinds, confidence remains strong on the company's relative performance.

AI Integration and Revenue Disclosure Evolution

The AI narrative continues evolving, with companies potentially changing how they disclose AI-related revenues. While HCL Tech had previously quantified AI revenues at around 3% of its topline, global peers are reconsidering such specific disclosures.

Nayak highlighted Accenture's approach: "Accenture has always been disclosing those Gen-AI revenues… but what Accenture is doing now is that, going forward, they will not be disclosing their Gen-AI revenues because they have said that Gen-AI is infused into every deal that they are now getting into."

This trend is expected to extend to Indian IT companies as AI becomes embedded across services rather than remaining a standalone revenue line.

Currency Impact and Margin Dynamics

The rupee's depreciation of nearly 2% versus the previous quarter is expected to provide some support, particularly benefiting companies with higher US exposure. "Generally, every 100 bps of rupee depreciation results in 30 to 40 bps positive impact as far as the margins are concerned," Nayak explained.

However, this currency benefit may be largely offset by wage hikes across both large-cap and mid-cap players, limiting scope for meaningful margin expansion. LTIMindtree is anticipated to remain the fastest-growing among large players, with Q4 expected to be stronger than Q3 due to deal ramp-ups.

The Q3 earnings season for IT is shaping up to be one of resilience rather than acceleration, with steady revenues, cautious margins, and deal momentum likely to drive stock-specific reactions more than headline growth numbers.

The December quarter is shaping up to be a challenging period for India's IT sector, with market expert Sandip Agarwal from Sowilo Investment Managers advising investors to prioritize management commentary over reported numbers as the earnings season approaches. Speaking to ET Now, Agarwal highlighted how seasonal factors and structural industry changes are likely to impact Q3 performance across the sector.

Seasonal Headwinds Impact Q3 Performance

The third quarter faces significant seasonal challenges that are expected to limit growth potential across IT companies. Agarwal explained that December month furloughs, particularly affecting manufacturing-linked businesses, have substantially reduced the number of working days available for revenue generation.

"This quarter, as you know, there is a December month where there are furloughs on the manufacturing side, and because of that the working days themselves are low. So, expecting anything big in this quarter from any company is a little difficult," Agarwal noted. He anticipates modest quarters with flattish growth for large IT names, while margin pressures are expected to remain contained due to limited cost escalation.

Management Commentary Takes Precedence

According to Agarwal, this quarter represents one where forward-looking commentary significantly outweighs reported financial metrics in importance. The timing coincides with the traditional budget communication period when clients typically share their spending plans with IT vendors during the first week of January.

"In my view, this is a quarter where commentary has always been more important than numbers. In the IT world, the first week of January is when budgets from clients start getting communicated to vendors, and some colour of that most managements should be able to give," he explained. However, he cautioned that meaningful growth recovery remains distant, suggesting the sector may not see strong growth numbers for the next 12 to 18 months.

Deal Environment Remains Challenging

The deal momentum continues to face headwinds, with expectations remaining tempered even for early reporters like TCS and HCL Technologies. Agarwal noted the absence of major deal announcements during the quarter and expects book-to-bill ratios to remain around one or slightly below.

A significant structural shift has emerged in the industry landscape, where smaller and mid-sized players now compete aggressively for deals that were once dominated by large incumbents. "The challenge is that a lot of these small and mid-sized players are now participating in every deal. If you see the top two Indian IT players, the return of the last four to five years on the stock is almost zero," Agarwal observed.

AI Impact on Margins, Not Growth

While artificial intelligence continues to feature prominently in deal discussions, Agarwal cautioned against expecting dramatic near-term transformation of company financials. He believes AI adoption will primarily support margin protection rather than drive significant revenue growth.

"You would not see much margin decline in the sector for the next few years because employee numbers will keep going slightly down, or revenue growth will be higher than employee growth for sure," he explained. The expert expects this trend to continue and accelerate, supported by currency tailwinds and reduced wage pressure.

Investment Strategy and Valuation Approach

Agarwal suggested a reversal of traditional investment preferences within the IT sector, recommending smaller companies over larger ones. He provided a clear framework: "You should prefer smallcap over midcap and prefer midcap over largecap. That should be the order because of the changing dynamics of the industry."

Regarding valuation metrics, he emphasized the importance of using PEG ratios instead of traditional PE ratios given the sector's limited growth profile. "PE ratio is completely misleading. There is no growth. When you look at the PEG ratio, you will be surprised that what looks expensive on PE is not actually expensive," he noted, while highlighting that ER&D-focused companies remain attractive despite current expensive valuations.