IT Companies- what lies ahead in FY23

IT has been one of the best-performing sectors in the post-pandemic era as disruption caused by Covid-19 lockdowns forced companies to automate and increased tech spends. This sent trading multiples for several stocks in the sector to record highs. Let us look at what lies ahead for this sector in FY23.

Concerns over a slowdown in growth

The analysis on the IT sector by foreign brokerages is that FY23 may not see the kind of growth as seen in the previous two financial years. Nomura warned of sharp deceleration in growth rates for the sector as companies scale back their tech spends amid a challenging micro environment. The brokerage reduced their target prices between 16 and 38 per cent.

Similarly, JP Morgan warned of “dark skies” for the domestic IT sector as it believed “peak revenue growth is behind us and EBIT margins trending down from inflation, mean reversion.”

 

Wipro was a stand out performer with annual revenues rising by 26.5% in FY22

 

According to the brokerage, enterprises’ will continue to spend on digital transformation, but growth rates on spends are likely to decrease substantially. The rally in the IT stocks was underpinned by sharp year-on-year growth in revenues during FY22. The top-tier tech stocks saw an average growth in revenues of close to 20 per cent, while tier-II companies saw a growth of 25 per cent.

Analysts tracking the IT sector, are expecting revenue growth for large IT companies to fall to 13 per cent in FY23 and to below 10 per cent in FY24. To add to this, companies are expected to face margin pressures. This has prompted analysts to have a cautious view on the sector.

Indian IT growth was accelerating till Q3FY22 but began to slow down from Q4FY22. With peak sector growth behind, growth deceleration should continue to weigh on sector multiples was the view of JP Morgan. It added that Indian IT services are the most expensive services names globally at a premium to tier-2 Indian IT companies and Accenture, and at par with enterprise software that appears unsustainable. 

IT stocks have been reeling under pressure following the sharp outflows of global investors, which have pulled out close to Rs 1.65 lakh crore from the Indian equity markets in the current year. Majority of the IT players have missed the consensus growth expectations and the margin outlook has been moderate. BSE IT index is down by 8 per cent in the current year so far.

IT companies stock values are moving down since Jan 2022

IT stocks are under pressure despite weak rupee. IT stocks are witnessing selling pressure as the margins have declined on account of supply side pressures. As the manpower expense increased, the margins reduced due to higher attrition rates, which resulted in slower growth in profits as compared to revenue growth. Another factor contributing to IT sector fall is the US Fed tightening its monetary policy to fight inflation, putting pressure on US indices and FIIs outflow from Indian markets.

 

Most IT companies lose more than 20% of their stock value from January 2022

 

Rising attrition across the board is a matter of concern

IT giants are battling attrition with employees are leaving their jobs like there’s no tomorrow. The attrition rate for some IT firms is at a whopping 25% , that means, 1 in 4 employees are leaving every year. Last year, Microsoft India’s first annual Work Trend Index reported that over 62% of employees felt their companies were demanding too much. Another 32% felt exhausted with the whole work-from-home trend. 

Another reason is that freshers salaries have been stagnant in IT companies for nearly ten years. In spite of large pool to choose from, freshers seem unwilling to join if you’re paying them measly salaries. They look for options like freelancing, gig economy, or just studying some more. It is time that IT companies review their compensation structure to retain fresh hires.

 

Attrition was highest in Q4FY22 in most IT companies with Infosys attrition rate touching 27.7%

 

IT companies face competition from start-ups in retaining talent. India is the third-largest startup ecosystem after the US and China and the country has over 10,000 technology-led startups who have gone on to create nearly 6.5 lakh jobs. These companies are ready to pay better to hire good talent. 

Established software firms are also losing employees to the new-age startups which are in their hyperscaling phase. Flush with funds, startups are drawing software engineers by offering above-market salaries, flexible work arrangements and generous employee stock options (ESOPs).

Hiring is at an all time high

Many IT companies has also won large multi-million $ multi-year contracts. IT companies hiring is the highest in recent years to meet thr demand of manpower for these projects. 

TCS also plans to hire over 40,000 in FY23. During Q4 earnings call, Samir Seksaria, Chief Financial Officer, TCS said, “We had an all-time high net addition in the quarter as well as for the full year at 35,209 and 103,546 respectively, bringing the total headcount to 592,195.

 

TCS added more than one lakh people to its workforce in FY22

 

Meanwhile, Indian IT players are also buying companies overseas. This is a bid to widen their offerings, and scale up international operations. Wipro recently announced the acquisition of US-based Rizing Intermediate Holding. It’s an SAP consulting company. The valuation was nearly ₹40 bn. Earlier, Tech Mahindra acquisition of European IT-company Com Tec Co IT for  Euro 310 million (nearly ₹26.4 bn) was at nearly four times annualizing calendar year 2021 sales of the overseas player. Wipro has done several overseas acquisitions over the last few years. In April 2021, it had announced the acquisition of Australia-based Ampion for nearly ₹8.5 bn. It also bought a UK-based IT consultancy Capco, in March 2021 for nearly ₹90 bn.

While IT companies had a good run in FY22, there are several challenges in FY23 which these companies will need to find solutions to. While some situations are driven by external challenges like tightening of spends buy clients, internal challenges like the high rate of attrition need to be addressed immediately. 

Many companies have won multi years deals which will need adequate manpower prompting hiring to reach new highs. It needs to be seen if the industry can maintain its margins in FY23 with suitable solutions to challenges that are currently existing.