NAVIGATING THE FUTURE OF INDIAN IT SERVICES INDUSTRY

While the long-term growth story remains intact, clients are cautious about decisionmaking due to uncertainties arising from the banking crisis in the US and an overall challenging macroeconomic environment.

By Ayushman Baruah

Indian IT services companies are facing pressure on revenue growth as there is increased cautiousness among clients around decision-making due to heightened uncertainties arising from the banking crisis in the US and an overall challenging macro-economic environment.

“Deal pipelines have not shrunk, but conversion to new deal wins is taking longer time. Also, in certain cases, conversion of orderbook to revenues in terms of deal rampups is taking longer than usual. This, in our view, implies right-shifting or postponement of demand to H2 FY24 or even FY25 as digitalisation agenda of clients remains largely intact, but their near-term focus has shifted to cost optimisation and increasing efficiency,” ICICI Securities said in a report.

Q4 (January-March) is seasonally weak for IT companies on account of fewer working days and some additional furloughs in January. Q4 this year has been eventful for the IT sector wherein on the one hand global IT giant Accenture continued to report strong bookings in the outsourcing business while, on the other hand, we witnessed fast paced events unfolding in the global BFSI space (30-38% revenue mix for top three IT players).

Some IT players have clarified that they do not have meaningful exposure to regional US banks, which are in financial trouble. Hence, the impact is expected to be minimal. BFSI sector in the US contributes about 19-20% to the topline of Indian IT services companies.

“The macro environment remains challenging for IT companies as decision making has been on the slower side…Clients continue to spend on cloud transformation, which is a multi-year opportunity while cost take out deals continue to form a bigger pie in the deals,” ICICI Securities said in a note.

Accenture Barometer

Global IT major Accenture has cut the top-end of its FY23 revenue growth guidance to 8-10% from 8-11% earlier, indicating challenges ahead for the Indian IT services companies. However, the mid-point of its organic growth guidance of 6-8% remained same as that of earlier guidance of 5.5-8.5%.

Accenture’s earnings are seen as an indicator for future performance of the Indian IT services companies. Accenture, which follows a September-August financial year, reported a profit of $1.53 billion for the second quarter. The IT giant also announced that it will cut about 19,000 jobs.

Accenture numbers for the outsourcing business were strong as it reported 31.8% YoY growth in outsourcing bookings. This offers positive signals for Indian IT companies, which are largely dependent on outsourcing.

Accenture’s consulting bookings were healthy, down only 2% YoY, compared to 14% decline in Q1 FY23. Absolute consulting bookings stood at $10.65 billion, its second-highest ever. Most verticals – financial services, health & public services, resources and products – grew in double digits. Growth in Europe was strong despite greater macro weakness in the region compared to the US. “Despite strong bookings, pipeline is being replenished with skew towards larger transformational deals focusing on cost optimisation,” analysts at ICICI Securities said.

Q4 EARNINGS TATA CONSULTANCY SERVICES (TCS)

Tata Consultancy Services (TCS), India’s largest IT services company by revenue, kicked off the fourth quarter earnings season on April 12 with a 14.8% YoY rise in net profit to Rs 11,436 crore. TCS follows an April-March fiscal year.

The Mumbai-headquartered company’s revenue for the March quarter grew nearly 17% from a year ago to Rs 59,162 crore, driven by longterm demand for technology-led transformation.

The dollar revenue for the March quarter grew 10.7% in constant currency from a year earlier to $7.2 billion. This is despite Q4 being a seasonally weak quarter on account of furloughs or lower number of working days due to holidays. The total contract value (TCV) in Q4 stood at $10 billion with all-time high number of large deals. For FY23, the order book stood at $34.1 billion.

“It is very satisfying to look back at our strong growth in FY 2023, on top of the mid-teen growth in the prior year. The strength of our order book demonstrates the resilience of demand for our services and gives us visibility for growth in the medium term. Krithi and I are working closely to ensure that the leadership transition over the next few months is smooth and seamless to all our stakeholders, and that TCS is well positioned to capture the opportunities ahead,” said Rajesh Gopinathan, CEO and MD, TCS.

Gopinathan added that the company is not seeing any large-scale budget transformations though some “discretionary projects are being deferred.”

K Krithivasan will take over as CEO and MD of TCS from June 1, 2023 replacing Rajesh Gopinathan. Krithivasan said his top priorities would include meeting customers and understand their requirements, meeting the larger TCS team, and focus on the nonBFSI side of business.

Indian IT companies reported robust earnings during the pandemic as demand for digital soared. But the peak revenue growth is likely to be behind them and the momentum is seen softening now on account of absence of large deal wins and clients selectively postponing their technology spends. Margins are under pressure due to wage hikes, higher backfilling costs, and increase in travel, visa, and other discretionary expenses.

TCS’s operating margin for the fourth quarter remained stable at 24.5% compared to the preceding three months.

On a trailing 12-month basis, the attrition rate reduced to 20.1% from 21.3% in the December quarter, indicating it is gradually coming down.

TCS made a net addition of 821 employees in Q4 and 22,600 people for the year, taking the total headcount to 614,795 as on March 31, 2023.

Infosys

Infosys, India’s second largest software exporter by revenue, has forecast its FY24 revenue growth to be in the range of 4-7% in constant currency, on the back of an uncertain demand environment and some unplanned project ramp downs and delays in decision making in Q4. The operating margin guidance for FY24 stood at 20-22%. Infosys follows an April-March fiscal year.

The Bengaluru-based company’s net profit for the March quarter rose 7.8% from a year ago to Rs 6,128 crore, below Bloomberg estimates of Rs 6,582.2 crore.

The revenue for the March quarter rose 16% annually to Rs 37,441 crore on broad-based growth, below Bloomberg estimates of Rs 38,769.8 crore. The revenue for FY23 grew 15.4% in constant currency to Rs 146,767 crore, below its guidance of 16-16.5%.

The dollar revenue declined 3.2% sequentially in constant currency to $4.5 billion due to deal ramp downs and a one-time revenue impact. In comparison, Tata Consultancy Services’ (TCS) dollar revenue grew 0.6% sequentially to $7.2 billion during the fourth quarter, below market expectations. During Q4, Infosys signed large deals worth a total contract value of $2.1 billion.

Analysts believe the softness in Q4 is much higher than what the companies had anticipated in Q3, and the situation has further worsened with the weakness in the US regions, especially the banking sector.

“As the environment has changed, we see strong interest from our clients for efficiency, cost and consolidation opportunities, resulting in a strong large deal pipeline. We have expanded our internal program on efficiency and cost to build a path to higher margins in the medium term. We continue to invest in our people and in supporting our clients,” said Salil Parekh, CEO and MD, Infosys.

Operating margins for the March quarter narrowed to 21% from 21.5% compared to the December quarter. “Our continued focus on cost optimization and operational efficiencies have helped in achieving operating margins of 21% in FY23,” said Nilanjan Roy, Chief Financial Officer, Infosys.

The company’s digital revenues grew 15% YoY in constant currency to $2.9 billion and contributed nearly 63% to the total revenues as of the quarter ended March.

Financial services and retail are the largest verticals which together account for close to half the revenues for Infosys. Revenues from financial services grew 0.4% annually in constant currency and contributed 28.9% to the total revenue for the March quarter. Revenues from retail grew 12.6% in constant currency, contributing 14.8% to the total revenues as of March quarter.

The attrition rate moderated to 20.9% from 24.3% in the preceding three months indicating the supply-side pressures are gradually coming down. The total headcount as of the March quarter stood at 343,234 employees.

Hcltech

HCLTech has forecast its FY24 revenue growth to be in the range of 6-8% in constant currency, somewhat better than the 4-7% guidance provided by peer Infosys. The EBIT margin guidance for FY24 stood at 18-19%.

The Noida-based IT services major posted a net profit of Rs 3,983 crore for the March quarter, up 10.8% from a year ago, but down 2.8% sequentially, amid a challenging business environment with clients cutting down on discretionary budget.

The revenue for the March quarter was up 17.7% from the year-ago period to Rs 26,606 crore as digital revenues continue to show demand. The digital revenue for the fourth quarter grew nearly 17% YoY in constant currency and contributed 37.5% of HCLTech services revenue.

The company’s dollar revenue for the March quarter grew 10.5% annually in constant currency to $3.2 billion, but declined 1.2% sequentially, indicative of a tough business environment.

“Our pipeline is near an all-time high which reflects our differentiated business mix and strong client demand for our offerings,” C. Vijayakumar, CEO and MD, HCLTech.

Analysts expect HCLTech to grow faster than both Infosys and TCS in FY24. “We estimate HCLTech growth at 7.9% YoY in CC terms for FY24, close to the top end of the guidance of

6-8%. As a result, we increase our revenue forecasts over FY24-26 by up to 2% each year. On EBIT margin, we have lowered our outer year assumptions due to the company’s higher focus on cost take-out deals in which margins are lower,” ICICI Securities said in a post earnings note.

The attrition rate for the March quarter reduced to 19.5% from 21.7% in the December quarter indicating a constrained job market across the sector. The company made a net addition of 3,674 employees during the quarter, taking the total headcount to 225,944.

The Way Ahead

The near- and medium-term future of Indian IT services companies looks challenging as clients turn cautious due to heightened uncertainties arising from the banking crisis in the US and an overall challenging macro-economic environment. However, the long-term growth story remains intact as demand for digital services continue to be robust. The global digital transformation spending is forecast to reach $3.4 trillion in 2026 with a five-year compound annual growth rate (CAGR) of 16.3%, according to International Data Corporation (IDC). Given the expertise and value proposition they offer, Indian IT services companies are expected to be a big beneficiary of the global digital transformation game plan.