Q4 IT Preview: Deal Momentum Expected To Drive Growth, Margins Under Pressure

India's largest software services providers are estimated to report growth in the quarter ended March, aided by new deals and cloud services, even as wage hikes and attrition continue to be a drag on margins.

The aggregate revenue of top five IT companies in terms of market capitalisation—Tata Consultancy Services Ltd., Infosys Ltd., Wipro Ltd., HCL Technologies Ltd. and Tech Mahindra Ltd.—is expected to rise nearly 2.71% sequentially, according to analysts’ estimates compiled by Bloomberg. The combined net profit is seen rising nearly 1.78%.

Estimates peg the highest revenue growth for Tech Mahindra at 5.26%. It's net profit is estimated to rise 5.25%. Analysts see HCL Technologies' profit falling 3.52% fall the fourth quarter.

That pressure on profitability persists. More headwinds including salary inflation, high attrition levels, resumption of travel, higher visa costs persist for Indian information technology companies, Nomura said in a report. That's in contrast with tailwinds like price increases in certain projects and limited currency depreciation in the near term, it said.

While Morgan Stanley sees strong demand trends, it said fulfillment poses a challenge for the companies. And owing to macro volatility, the outlook for fiscal could be "conservative, baking in potential risks in second half", it said.

Nomura expects the EBIT margins to remain moderate in FY23. “We do expect EBIT margins to improve in FY24F due to normalisation of attrition in the next 1-2 quarters, continued pyramid optimisation by companies and price hikes in the contracts,” it said.

• The brokerage pegged TCS' operating margin at 25.3%, the highest among the top five IT companies, followed by Infosys at 23.5%.

• The average of analysts’ estimates compiled by Bloomberg pegged margins for Infosys and TCS at 24.87% and 23.42%, respectively.

Morgan Stanley underscored timing mismatch—increased cost in the first half of FY23 with benefits from potential price increases in the second. “We expect to see FY23 margins decline YoY, limiting any earnings upgrade potential,” it said.

Deal pipeline remained fast paced in the fourth quarter led by full-scale digital transformation, higher spends on cloud transformation, cloud data analytics and technology transformation.

Despite multiple headwinds, Motilal Oswal doesn't see a moderation in their medium-term demand commentary. Engineering and R&D services continue to do well on new deal signings, with annual contract value up 36% year-on-year, it said.

However, Nomura pointed out that geopolitical issues-led GDP downgrade risks impacting demand, particularly in Europe.

IT companies are expected to guide for double-digit revenue growth in FY23.

"We expect Infosys to give FY23 revenue growth guidance of 12-14% and FY23 EBIT margin in the range of 22-24%," Reliance Securities said. The brokerage expects a decline in the utilisation rate due to fresher hirings and a rise in discretionary costs.

"We expect Indian IT names to record mid-teen double-digit revenue growth in FY23 and maintain margins around the current level in first half of FY23, while margins would improve by 50-100 bps in second half," it said.

In the quarter ended March, the Nifty IT Index fell nearly 6.16%, led by Coforge (formerly NIIT Technologies) , Wipro, L&T Technology, Tech Mahindra and HCL Technologies. The Nifty 50 gained 0.64% during the period.

• Client budget

• Impact on European region

• Supply-side issues

• Cost escalation