IT Sector might be seen in pressure in Q2FY23 while it may improve going forward

The results season for the Q2FY23 has already started, and companies across all industries have declared the dates on which they will release their quarterly results, but few have already provided business updates for Q2FY23. Street projections for the upcoming quarter have begun to take shape as analysts and brokerages share their perspectives. In light of all of this, the IT industry will be the first to report Q2FY23 results, with TCS leading the way on October 10 and the rest following in the next 5 to 6 days.

IT Sector which up till now have seen major pressure on their margins owing to astronomically high levels of attrition in the past one year. The average attrition rate is almost 20% across industry. This has made the IT sector one of the highest losers in 2022 YTD. NIFTYIT has underperformed NIFTY50 by huge margin of 26.93%, as NIFTYIT fell 27.58 while NIFTY fell 0.58% YTD.

While there has apparently been lesser attrition in Q2FY23 in IT organisations since staff are staying home due to fears of a recession. Other reason could be that IT firms might have a better grasp on labour costs. Broker estimates, however, indicate that cross currency headwinds will likely reduce net margins by roughly 200 bps. Although the dollar is still strengthening, the declines in the British pound, the euro, the Japanese yen, and the Australian dollar would more than outweigh those gains. Therefore, Q2FY23 shall be another quarter of pressure for IT companies, but it may be start of margins bottoming out and improve from H2FY23. Let’s now look at the expectations from the major companies in this sector to understand the entire picture in an efficient manner.

Robust Revenue expected despite several headwinds

Analysts anticipate IT companies to post a “resilient” quarterly performance with 2-4% sequential rise in revenues despite all the talk of a downturn in demand from the US and European nations. “In the context of the current macro environment, the IT sector is anticipated to show resilient Q2 performance.” According to experts at HDFC Securities, Tier-1 IT companies are anticipated to show sequential growth in the range of 2.4 to 4% in constant currency.

TCS has declared its results on 10th October 2022 and it registered a consolidated net profit of Rs 10,465 crore, an 8.41% YoY growth from Rs 9,653 crore in Q2FY22. Revenue from operations grew by 18.01% YoY to Rs 55,309 crore compared to Rs 46,867 crore in Q2FY22. Sequentially, revenue grew 4.83%. In CC (Constant Currency) terms, revenue growth was 15.4% YoY. Operating margin in Q2FY23 was 24%, lower by 1.6% on a YoY basis. The company’s order book for Q2FY23 stood at $8.1 billion. While this result was above the analyst expectations, the results of the other IT companies need to be evaluated in order to get a sense of the trends in the IT sector.

On the back of good momentum and the ramp up of prior deals, Infosys anticipates significant CC revenue growth of +5.3%. In spite of predicted reduced utilisation, senior management wage increases, and travel costs, margins are expected to rise marginally by +30bps QoQ due to the weaker USD/INR exchange rate and operational efficiencies. Investors can anticipate Infosys to stick to its guidance for 21-23% EBIT margin and 14-16% CC revenue growth.

In accordance with its projected range of 3-5% on large deal ramp ups, Wipro anticipates IT services CC revenue growth of +4.0%; this figure will take Rising’s two-month impact into account. With headwinds including salary increases and promotions, offset by growth, better utilisation, and efficiencies, margins are predicted to climb just moderately (+20bps). Investors should anticipate Wipro to forecast CC QoQ growth of +1% to +3% in Q3.

HCL Tech anticipates CC revenue to increase by +4.0%. While P&P will remain modest, services (IT services & ER&D) will be the growth drivers. As HCL will spread out salary increases throughout Q2 and Q3, this is expected to be partially offset by growth and operational improvements, resulting in a slight (+40bps) expansion of margins. Investors might anticipate that HCL would stick to its growth (12-14% CC) and margins estimate (18-20%) for FY23.

Finally, Tech Mahindra anticipate CC revenue growth to be moderate, at +2.1% QoQ. Telecom is likely to drive the expansion. Margin expansion is anticipated to be mild (+30bps), as operational improvements will partially offset the impact of pay increases (80-100bps).

Margins have almost bottomed out with increased control over Attrition

Most brokerages’ analyses indicate that the decline in IT firms’ margins may have reached a bottom at this time. Since their post-Covid peak levels, IT sector margins have decreased by 400 bps.

IT companies have recently adopted several actions to stop the decline in their profits, including reserving variables for workers. However, analysts predicted that Q2 margin will be affected by wage and cross-currency effects, which will be partially offset by the absence of visa fees, INR depreciation, greater utilisation, and increased efficiencies.

The previous quarter was distinguished by the rupee’s steep devaluation versus the US dollar, which is typically seen favourably by IT companies that focus on exports. However, the sector is also concerned about the weakening euro and pound. So, an overall net effect is expected to be negative for almost all the major IT firms.

Our View

Following the surge in revenue during the epidemic, the growth rate for IT companies has dropped in the post pandemic world. It is anticipated that it will decline even further as western economies struggle to recover from the conflict in Ukraine. Although top IT company management maintain that the recessionary pressure in Europe and the US won’t have a significant impact on growth, analysts have already begun lowering their predictions beyond the September quarter.

Investors might hunt for better alternatives in the mid tier IT stocks while waiting the top IT stocks to become bullish on technical charts. Although the situation could seem to be improving on the one hand, the best course of action is to analyse each company’s specific results as well as the industry’s trend and see how things roll out for each participant individually. The same information is available on the Univest website and mobile app, along with detailed analysis of each company.

 

ABOUT THE AUTHOR

Ketan Sonalkar (SEBI Rgn No INA000011255)

Ketan Sonalkar is a certified SEBI registered investment advisor and head of research at Univest. He is one of the finest financial trainers, with a track record of having trained more than 2000 people in offline and online models. He serves as a consultant advisor to leading fintech and financial data firms. He has over 15 years of working experience in the finance field. He runs Advisory Services for Direct Equities and Personal Finance Transformation.

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

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