Margin pressure may linger for top 4 IT firms

Q1 data show divergent strategies resulted in different results

For the past three-four quarters, the Indian IT services industry has ridden the cloud and digital transformation wave that was accelerated by the pandemic. However, the top four players may face some pressure on margins. A closer look at their first quarter (Q1) numbers reveals that their different strategies resulted in divergent performances.

If one looks at absolute numbers, Wipro seems to be leading the pack, as the acquisition of Capco aided growth. Without Capco, Infosys leads the pack in Q1 performance.

Analysts that Business Standard spoke to also voted for Infosys, for not only reporting consistent growth numbers, but also because it revised its guidance for financial year 202122 (FY22) and beat Tata Consultancy Services (TCS) in revenue growth.

In Q1, TCS reported US dollar revenue growth of 2.4 per cent sequentially, which disappointed the Street. Especially when compared to Infosys’ 4.8 per cent constant currency sequential numbers. TCS’ Q1 show was impacted by its India business, which was down almost 14 per cent sequentially. The management stated that the company saw a ~350 crore loss in India and the second wave of Covid-19 impacted not just ION, but other projects too.

This is also because of its strategy, which is different from peers. TCS has the largest presence in India. In Q1, the Indian share of its revenue was 4.3 per cent, while it was 3 per cent for Infosys. Wipro and HCL Tech do not share such numbers.

“Even adjusting for second wave impact (5.6 per cent of revenues in March, 14 per cent quarter-on-quarter decline), TCS’S growth in Q1FY22 would have been around 3.1 per cent QOQ (CC). Notably, this is softer than its pre-covid 5-year average growth in June —the strongest quarter seasonally. This further supports our key argument on the sector, ie, once the low base effect wanes, growth should converge with the pre-covid long-term average. Europe (17 per cent of revenues in March) remained a key overhang on growth,” said Sudheer Guntupalli, and Hardik Sangani of ICICI Securities.

In the case of HCL Tech, it reported the lowest revenue growth in US dollar terms, a 0.7 per cent sequential rise. The company attributed this due to softness in Europe and its IT services segment, and drop in product and platform vertical.

Having said that, all the top players reported healthy deal flows with total contract value (TCV) showing good deal wins in Q1. Though the Street was disappointed with TCS missing on growth, the overall performance was robust. It had a TCV $8.1 billion and was broad based, with BFSI having a TCV of $2.2 billion, retail saw an all-time high order book of $1.5 billion.

TCS reported the highest TCV among peers, followed by Infosys at $2.6 billion, HCL Tech at $1.67 billion, and Wipro with $715 million.

Experts say it will be a challenge to maintain good supply of talent to meet the demand, which will impact margins as was evident in Q1. Though Infosys led in performance and with its guidance, it did miss the margin expectations owing to salary hikes — Q1 margins were hit by 80 basis points due to increased use of third party sub-contractor cost.

Margins will continue to be an issue for Infosys, said a report by ICICI Securities. “Impending wage hikes in September, potential attrition interventions, high utilisations (89 per cent ex-trainees), higher fresher hiring (35,000 vs earlier plan of 25,000), revival of discretionary costs, and large deal rampup costs will likely mean exit margins may rhyme with that of FY19. This implies FY23E margins will likely trend to FY20 levels unless the company is able to pull off price increases or rupee depreciates meaningfully. Earnings miss this quarter and subdued margin expectations lead to 6 per cent downgrade to our FY22E-FY23E EPS.”