India's IT sector has commenced the earnings season with results that, while better than feared expectations, fall short of inspiring renewed investor confidence. Early reports from major players including Tata Consultancy Services and HCL Tech reveal a mixed picture where cost discipline and favorable currency movements are providing support, even as fundamental growth challenges persist.

Mixed Performance Indicators

Sandip Agarwal from Sowilo Investment Managers highlighted that the initial large-cap IT results have been "slightly better than what was anticipated," with both TCS and HCL Tech demonstrating effective cost management. However, he emphasized the importance of focusing on two critical metrics: the book-to-bill ratio and year-on-year constant currency growth.

The book-to-bill ratios for both companies showed reasonable stability, though this does not indicate any major demand revival or significant upside potential. More concerning is the persistent weakness in constant currency growth, which remains "very, very subdued" at levels below 5% across large IT firms.

Currency Benefits Mask Fundamental Weakness

Rupee depreciation has emerged as a crucial support factor for the sector's reported performance. While dollar-denominated and constant currency growth appears weak, translation benefits have provided a boost to reported rupee revenues and profits. Agarwal noted that "finally, for investors, it is the INR which also matters," acknowledging that currency gains and margin improvements are helping offset the lack of meaningful fundamental revenue growth.

Despite these supportive factors, valuation concerns persist. The analyst maintained that "on a PEG ratio basis, the whole sector is still very, very expensive and not attractive in our opinion."

Workforce Optimization and Operational Efficiency

TCS's approach to workforce management drew attention, with the company reducing approximately 11,000 employees during the quarter and nearly 30,000 since the financial year began. Agarwal characterized this manpower rationalization as "very, very reasonable," particularly given productivity improvements driven by artificial intelligence implementation.

The analyst praised Indian IT management teams as "very pragmatic" and "very calculated and measured in their approach," noting that failure to right-size operations could negatively impact margins and create operational inefficiencies.

Regulatory and Structural Challenges

TCS faced a one-time non-cash impact related to new labor code implementation, which Agarwal explained involves repricing future liabilities such as gratuity and leave encashment due to salary structure changes. While acknowledging maximum impact on organized sectors like IT and banking, he dismissed long-term concerns, stating that "the one-time impact is big, which cannot be considered as a recurring impact anyway, and the recurring part is very, very small."

HCL Tech distinguished itself with an 18.6% margin performance and upward guidance revision, delivering what Agarwal described as "definitely much better than estimates." This outperformance was largely attributed to the products and platforms business, which tends to be seasonal and occasionally delivers significant quarterly surprises.

Market Outlook and Investment Perspective

The analyst identified several structural challenges facing the industry, including market maturity and intensified competition. Post-Covid changes have lowered entry barriers, resulting in deal pipelines now featuring 10 to 12 bidders instead of the previous two or three, creating additional pressure on pricing and growth prospects.

Looking forward, Agarwal expects continued muted performance, citing factors such as furloughs in manufacturing-linked segments. He believes most IT companies could manage modest positive surprises this quarter, primarily because expectations have been significantly reduced. However, he concluded that "other than INR depreciation, there is no fundamental reason to be in the sector in the near term," suggesting that a meaningful correction in PEG ratios would be necessary to create attractive investment opportunities.

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.