Sector of the Week : IT Services Companies

Posted by : Siddhant | Wed Apr 27 2022

Sector of the Week : IT Services Companies

The Indian IT industry has been witnessing a stellar run in the last one and a half years. The Covid-19 pandemic-induced digital adoption drive across the world has pushed up the global IT spend, which benefitted both global and Indian technology firms. What is common to all IT companies is that the market is one of the strongest ever, as the world recovers from Covid-19 and moves to fully embrace digital transformation.

With the results season kicking off in April, the Q4 results give an insight for the complete financial year also. IT services companies are amongst the first to release their results and this quarter hasn’t been any different.

Starting with the IT services giant TCS, almost 10 companies including 3 of the top 5 Indian companies along with a host of large cap and mid cap IT services have released their Q4 numbers in the first three weeks of April. Across the board, companies irrespective of their market capitalisation, have demonstrated growth for the second year in a row. 

Growth across the board for IT companies

For FY22, most large firms and mid-tier companies are likely to report double-digit revenue growth. Results of Tata Consultancy Services (TCS), Infosys and Mindtree already reflect the growth achieved in FY22. IT heavyweights, TCS and Infosys achieved an annual revenue growth of 17% and 20.7% respectively. All IT companies that declared results have registered significant YoY growth in revenues as well profits in Q4 also.

As we enter FY23, there is now a cloud of uncertainty over sustaining the growth momentum. The global market, supply chain, and commodity prices are major concerns along with an inflationary environment owing to the ongoing Russia-Ukraine crisis. 

Europe as a continent is likely to face difficulties over oil & gas supply to key industrial nations. Any economic disturbance is likely to affect the clients’ decision making on technology spends going ahead. Moreover, inflationary environment is expected to reduce the profits of global enterprises, and companies would be cautious on technology spends. 

In such an environment, Indian IT companies may see a decline in the demand environment as compared to the last financial year. The deal pipeline for most IT companies has remained robust with the average value of deal sizes increasing. However, there is uncertainty over new deal wins in the coming quarters. 

To maintain the growth momentum, Indian IT firms are expected to accelerate the pace of automation to save cost apart from tapping new geographies. India as a market has not received the required attention so far by most domestic service providers. While many global majors have successfully tapped the Indian market, most domestic IT firms are yet to do so. There are umpteen opportunities for the Indian IT industry in the private sector as well as large government contracts.

Larger deal wins likely to drive future performance

The Indian IT sector is expected to deliver strong performance owing to increase in number and size of deals happening in this space, combined with an increase in demand from clients. Guidance by few firms on growth indicates incremental employment of two lakh employees by top five IT firms over the last financial year alone. The Indian IT sector is expected to continue to benefit as more companies in the world’s biggest economies look to move a greater share of their information technology workloads to the cloud and adopt digital transformation projects.

Going forward, IT companies are expected to continue to post strong growth numbers on account of digital and cloud transformation initiatives with enterprise clients. The financial metrics for FY22 for the top 3, large cap as well as mid cap IT services companies point to a very healthy numbers for annual profit margins, annual revenue growth as well as EBIT margins. The ROE (return on equity) indicates 12.3% for Cyient at the lower end to as high as 37.5% for TCS. The ROCE (return on capital employed) is also above 25% for most of the companies.

Attrition remains a matter of concern

One of biggest concerns for the Indian IT companies is attrition and the ongoing talent war, as everyone fights to attract the same set of software engineers. These include listed Indian companies as well as IT multinationals with large software centres in India, heavily funded Indian start-ups and even a new generation of tech companies from across the world, who are setting up and expanding development centres in Bengaluru, Hyderabad, Pune and Chennai.

High attrition is pushing wage cost and related expenses as IT firms compete in the marketplace to hire and retain good talent in a robust demand environment. Moreover, resumption of travel and opening of offices will also raise expenses on these accounts. Cross currency movement is another matter of concern. While the prospects for further growth are intact, FY23 is likely to see pressure on operating margins of Indian IT firms.

Note – This channel is for educational and training purpose only & any stock mentioned here should not be taken as a tip/recommendation/advice

Research done by: Ketan Sonalkar, SEBI Rgn No INA000011255

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