Inflation cast a long shadow over Q3FY23 for FMCG companies, as costs ate away at volume and demand growth. Rising costs forced FMCG firms to focus on price hikes for revenue growth, and rural consumption dropped for the sixth consecutive quarter. The depreciating rupee didn’t help - that along with input cost pressures and sluggish demand, worsened pressures on margins.

Although the festive season aided sales in Q2FY23, the momentum has slowed down since. Nielsen IQ reported that the FMCG industry in India grew by 7.6% in Q3FY23, compared to 9.2% in Q2.

What about Q4? It’s hard for FMCG CEOs to be too optimistic right now, considering predictions of a hot summer and possibly weaker monsoons. This would put even more pressure on the rural consumer, and hurt demand recovery. The US government’s weather agency, National Oceanic and Atmospheric Administration, predicts a 49% chance of El Nino impacting monsoons in June-July and a 57% impact chance in July-September. However, experts say that more clarity about rainfall will emerge in April-May.   

The rural market makes up nearly 35% of the FMCG industry’s sales, and low demand from this market will mute growth prospects. However, some companies are optimistic about rural demand picking up on the back of a robust winter harvest and the Centre’s rural infrastructure push.

Mohit Malhotra, CEO of Dabur India, says, “The operating environment remained challenging during the quarter, rural markets continued to face a slowdown on account of high inflation, uneven distribution of monsoon and down trading by consumers. Having said that, the new age channels performed very well and some green shoots are visible in the rural markets, indicating an early revival in demand.”

Meanwhile, the management of Hindustan Unilever (HUL) maintains a moderately optimistic outlook on demand recovery. But it is clear that recovery in rural demand is dependent on healthy rainfall and decline in inflation - and the direction of both isn’t obvious right now.

Most FMCG players underperform the Nifty 50 index

The delay in rural demand recovery has taken a toll on the FMCG sector, causing it to fall over the past six months. 

Only Britannia Industries has comfortably outperformed the Nifty 50 index. The other five companies’ share prices declined during the same time period. The Nifty 50 index fell 3.8% amid heavy volatility.

Large FMCG companies have good durability scores but trade at expensive levels

According to Trendlyne’s DVM classification, Hindustan Unilever, Nestle India, Britannia and Tata Consumer Products have high durability scores.

Meanwhile, all the FMCG players in focus have medium momentum scores, suggesting average to low bullishness in the market, and weak valuation scores, implying that they are trading at relatively expensive levels. 

Revenue growth continues to be driven by price hikes

All the companies in focus have witnessed revenue growth on a YoY basis in Q3FY23. Price hikes continued to be the main growth driver yet again as demand was stifled due to inflationary pressures. FMCG companies focused on improving their product mix as most customers were downtrading and buying goods in smaller quantities. 

With a growth rate of 17.4% YoY, Britannia Industries leads the pack. It is followed by Hindustan Unilever with a growth rate of 16.1%. Dabur’s revenue has grown the least at 3.5% YoY, given that it has the highest exposure to the rural market. According to the management, the late onset of winter also affected its sales.

High retail inflation eats into demand 

Despite FMCG companies passing on the benefits of falling commodity prices to customers, volumes are yet to see significant growth. Reports suggest that price growth in the industry has declined by 200 bps YoY to 7.9% in Q3FY23. Still, customers preferred downtrading to cheaper options, and demand was weak.

Looking at the trends of the wholesale price index (WPI) and consumer price index (CPI) may provide clarity on why retail demand is still weak. The WPI-based inflation has consistently declined since May 2022 and touched a 24-month low of 4.73% in January 2023. Due to a fall in the prices of fuel & power and manufactured products. Whereas, the CPI-based inflation increased to 6.52% in January 2023.

One of the major reasons for this movement in opposite directions could be the difference in weightage each of the indices give to food. CPI gives around 50% weightage to food articles, while it is only 24.4% for the other. Prices of food items like cereals, milk, meat and eggs have risen sharply, leading to high food inflation.

Suresh Narayan, MD & Chairman of Nestle India, believes that consumer price inflation in January crossed 6% due to high food inflation. He adds, “Food inflation is clearly an area to watch out for as far as the company is concerned.”

As high levels of food inflation hurt customers’ ability to spend, demand will likely take longer to recover.

Cost optimisations drive net profit growth

All FMCG players barring Dabur India, witnessed a rise in net profit. Profit growth was driven by healthy sales growth across segments and tight cost controls. Most companies initiated cost management and operational optimisation measures to improve profitability.

Britannia Industries leads the pack in terms of profit growth, with a 151.2% YoY surge on the back of low-cost wheat inventory and a one-off gain of Rs 375.6 crore from a 49% stake sale in one of its subsidiaries. Nestle India comes second with its net profit rising 62.4% YoY on a low base due to a one-off charge of Rs 236.5 crore last year.

Trendlyne’s Forecaster predicts decent revenue growth

Forecaster estimates a double-digit growth in revenue for HUL, Nestle, Britannia and Tata Consumer Products. Britannia Industries is expected to take the lead with a growth rate of 16.1% YoY followed by HUL (12.8% YoY).

However, the outlook for Dabur and Godrej Consumer is not as positive, a growth rate of 7.8% and 8.8% YoY respectively is anticipated.

High input costs continue to eat into margins

Most FMCG firms continue to see their gross margins erode on a YoY basis due to elevated commodity prices. Although prices of key commodities have fallen from their highs, input costs still remain relatively elevated. Most companies are also limiting price hikes to avoid losing market share.

Only Britannia and Godrej Consumer witnessed a YoY rise in margins this quarter. Britannia’s margin expanded on the back of its low-cost wheat inventory and cost-saving programs. Godrej’s margin growth was led by easing input cost pressures in its India business.

On a QoQ basis, most companies, barring Tata Consumer, saw margins improve on declining commodity prices. 

Recovery in rural demand may take longer than expected

FMCG companies expect input cost pressures to gradually reduce amid declining commodity prices. But if high retail inflation persists, demand recovery will take longer than expected. Revival of the rural market depends on healthy rainfall and with predictions of weak rainfall in 2023, the outlook for the rural market looks bleak.

FMCG businesses expect revenue growth to be price-led in the near-to-mid-term. Sanjiv Mehta, CEO & Managing Director of HUL, says, “We remain cautiously optimistic in the near term.” According to him, if commodity prices remain at their current levels, the worst of inflation might be behind the industry. “Having said that, we must be mindful that year-on-year inflation is still high, and so expect growth to be price-led,” he adds.

For FMCG players to see meaningful growth in the coming quarters, there must be an overall recovery in demand. For that, we must wait with fingers crossed for a good monsoon, and lower commodity prices. 

This analysis by Trendlyne is meant for investor education - to help understand companies and make informed investment decisions on their own. It should not be considered an investment recommendation.

The third quarter of the financial year, with its many festivals and weddings, is usually a strong one for the hotels industry. And this year didn’t disappoint – the hotels in focus reported robust growth in revenue and net profit in Q3FY23. Rising leisure travel, revenge tourism and improving corporate travel and events helped drive growth during the quarter.

It looks like pent-up demand from Q1FY23 has not yet fizzled out. In fact, Puneet Chhatwal, CEO of Indian Hotels Co, believes that the continuous rise in travel can no longer be attributed to pent-up demand, as nine months have gone by since the last wave of Covid ended. According to him, “There is a permanent shift in customer behaviour. They are now combining business with leisure, or taking extended weekends by driving to a destination and working from there.”

Companies are positive about the industry’s growth prospects in the near-to-midterm. They believe events like the ICC Men’s Cricket World Cup and the G20 Summit scheduled in India will provide a fillip to inbound travel and overall demand. Hotels also believe the demand-supply mismatch will enable them to command higher room rates even as occupancies increase.

All hotel stocks outperform the Nifty 50 Index

Riding on healthy quarterly results in Q2FY23 and Q3FY23, most of the companies in focus have comfortably outperformed the Nifty 50 Index over the past six months. Whereas, EIH declined 0.4% in the same period. Due to the volatility in the markets, Nifty 50 fell 1.2%. Indian Hotels and Chalet Hotels beat the index by the biggest margins.

The hotels industry has risen 9.5% over the past six months on the back of industry tailwinds. Among the four hotel chains in focus, only Indian Hotels managed to outperform the overall industry. 

Hotel stocks trade at expensive valuations

According to Trendlyne’s durability, valuation and momentum scores, only Indian Hotels and EIH have good durability scores, indicating strong financial health.

All the four hotels have medium momentum scores, suggesting average to low bullishness in the market.

However, all the stocks have weak valuation scores, which indicates that they are trading at relatively expensive levels.  

Revenues up on rising demand and room rates, Indian Hotels sees biggest bump 

A combination of robust demand and increasing room rates amid favourable demand-supply dynamics has boosted revenue growth across the board. On a YoY basis, all the companies in focus have posted revenue growth, with Chalet Hotels leading the pack with a 76.5% YoY increase in revenue.

Compared to the pre-covid quarter of Q3FY20, all hotels posted higher revenues. Indian Hotels’ revenue has increased by the biggest margin. Companies were able to post higher revenues despite relatively lower occupancy rates, due to a sharp increase in room tariffs.

For the near and medium term, these hotel chains expect strong momentum in revenue growth to continue, largely led by robust domestic demand and occupancy rates normalising to pre-pandemic levels amid elevated average room rates (ARR).

Operational efficiencies, cost management help margins and profitability

All the companies in focus saw a massive jump in profits on a YoY basis, when compared to Q3FY20. The improvement in profitability comes on the back of increasing rates along with cost reduction measures and operational efficiencies.  

Lemon Tree Hotels and Chalet Hotels were back in the black on a YoY basis in Q3FY23. Whereas, Indian Hotels and EIH witnessed a multi-fold jump in their net profits, rising 403.5% and 275.6% YoY respectively.

Comparing net profit growth to Q3FY20, Lemon Tree Hotels leads the pack with its profit surging 227.9%. Chalet Hotels comes in second with a 207.2% rise, but this is due to a one-off reversal of provisions worth Rs 60.5 crore.

On a YoY basis, Chalet Hotels’ EBITDA margin has improved the most with an expansion of 23.1 percentage points, led by its hospitality segment’s revenue growing 87% YoY. Compared to Q3FY20, Lemon Tree Hotels’ EBITDA margin expanded the most; it rose by 12.7 percentage points.  

Overall, all the companies in focus have been able to beat their Q3FY20 profit levels with robust expansion in margins led by cost management initiatives. With these initiatives in place, the four firms were able to decrease employee costs, utility costs and other operating costs as a percentage of revenue on a YoY basis and against Q3FY20.

Forecaster estimates healthy revenue growth in FY23

Trendlyne’s Forecaster estimates a robust surge in the annual revenue of the hotels in focus. Chalet Hotels is expected to lead the pack in revenue growth, with a surge of 113.6% YoY in FY23. Lemon Tree Hotels comes in second with its revenue expected to expand by 110.8%. Indian Hotels and EIH’s revenues are anticipated to grow by 85.3% and 61.5% YoY respectively.

Revenue growth will be driven by the continued traction in domestic demand along with a recovery in foreign demand despite elevated room rates. Hotels are expected to benefit from both improving occupancy rates and higher average room rates (ARRs) due to the favourable demand-supply scenario. ICICI Securities anticipates industry demand to grow at a CAGR of 10% over FY23-26 and supply to increase at a CAGR of less than 5% during the same time period.    

Average room rates rise as demand continues to gain traction

Organised hotel chains have been consistently hiking room rates for the past few quarters now, as they are optimistic about the demand momentum remaining steady for the coming quarters. Another factor leading to the increase in room rates across the industry is the demand-supply mismatch. According to HDFC Securities, demand is likely to outpace supply for the next two-three years, thus allowing hotels to push prices further, while occupancy rates recover.

All the companies in focus witnessed double-digit ARR growth compared to their pre-pandemic levels. Indian Hotels’ ARR grew 29.6% in Q3FY23 compared to its Q3FY20 levels, the highest among its peers.  

With high-interest rates and elevated commodity prices, it is unlikely for hotels to take up more construction projects. Until the macroeconomic conditions become more favourable, the demand-supply gap is likely to persist. For now, companies are focusing on renovating their current assets to increase room rates further.

Occupancy rates see gradual improvement but still behind pre-covid levels

Occupancy rates have improved YoY for all four hotels but are still behind pre-covid levels. Only EIH’s occupancy rates beat its pre-covid levels. The other three companies lag as they have been focusing on improving their revenue per available room (RevPAR) through higher room rates for the past few quarters.

Indian Hotels Co’s occupancy rate fell only by 50 bps against the levels in Q3FY20 and Lemon Tree’s dipped by 3.7 percentage points.

Chalet Hotels’ occupancy rate is behind its pre-pandemic levels by 10 percentage points. The company’s management attributes this to lower corporate travel during October and the last two weeks of December due to long holidays.

Increasing room rates drive jump in per room revenues 

The consistent rise in room rates across the Hotels industry has led to industry RevPAR beating pre-covid levels since Q1FY23. Among the four hotel chains in focus, only Chalet Hotels’ RevPAR is below its Q3FY20 levels. Its management believes lower occupancies offset higher ARRs, leading to a decline of 3.2% in RevPAR compared to its pre-pandemic levels.

Indian Hotels leads the pack in RevPAR growth, compared to Q3FY20, with an increase of 28.7%. The company’s management cites robust growth in key locations like Mumbai, Goa, Bengaluru and Delhi for this. EIH comes in second with a growth rate of 28.2%. Lemon Tree hotels has had a 17.1% growth, held back by the subdued performance of its Keys brand.

With a favourable demand-supply scenario still at play and travel nearly back to normal, the hotels in focus anticipate RevPAR to continue to grow on the back of rising room rates and occupancies.

Hotels to benefit from an upswing in industry cyclicity

With strong economic and industry tailwinds, hotels are expecting robust growth in Q4FY23 and FY24 as well. Patanjali Keswani, Managing Director of Lemon Trees, expects the company’s EBITDA margin in Q4FY23 to be well over its Q3FY23 levels. He anticipates the firm’s revenue in FY24 over FY23 to grow by 20% and net profit to surge by 40-50%.

The companies in focus expect inbound travel or foreign travel in India to reach pre-covid levels in Q4FY24. The management of EIH is particularly upbeat about foreign travel normalising, as the hotel generally has a larger share of foreign guests as compared to its peers in India.

The business environment for the industry is favourable due to the uptrend in demand and lagging supply. This allows organised hotel chains to command premium rates in the medium term. Unless another black swan event like Covid derails the upswing, hotels will benefit from the upcycle in the industry.

This analysis by Trendlyne is meant for investor education - to help understand companies and make informed investment decisions on their own. It should not be considered an investment recommendation.

Hindustan Unilever (HUL) was the first FMCG major to release its Q3FY23 results. Being the largest company in the FMCG sector, its results gave investors an early peek into consumer trends and how the rest of the industry might perform.  

The British multinational’s Indian arm delivered a strong Q3 performance, partly as a result of raising prices. Observers had worried that this could put off India’s rural customers, who are a mainstay of the business, but HUL posted a healthy set of numbers with underlying volume growth.  

Although inflation has seen a gradual decline, cost pressures still persist for FMCG companies. Sanjiv Mehta, CEO and Managing Director of HUL, said, “Year-on-year inflation is moderating from its peak, and consumer price inflation has also softened in recent months. (But) commodities remain at an elevated level when compared to long-term averages.” Along with elevated costs, the Indian rupee’s depreciation against the US dollar has added to the woes.

The management nevertheless believes that the worst is behind them. Ritesh Tiwari, CFO of HUL, said, “We remain cautiously optimistic in the near term. We believe peak inflation is behind us, and this should aid the gradual improvement of consumer demand.”

Price hikes continue to drive revenue growth

HUL’s revenue has grown by a healthy margin of 16.1% YoY to Rs 15,597 crore. As prices of key commodities are still relatively expensive, growth continues to be driven by price hikes. The management indicated that urban demand was still stronger than rural demand and premium products continued to outperform mass products. On the bright side, rural demand grew sequentially as inflation softened compared to the past quarter.  

Net profit has improved 7.7% YoY to Rs 2,474 crore with growth across all segments. The management claims over 75% of its portfolio gained market share in Q3. The average quarterly revenue and net profit growth of the FMCG sector is 10.6% and 9.5% respectively. However, FMCG stocks fell by 1.4% over the past week in a volatile market. 

Segment-wise, home care, and beauty & personal care performed the best with double-digit growth, and made up more than 70% of HUL’s revenue. The home care segment’s strong performance was backed by value and volume growth despite calibrated price hikes.

The beauty & personal care segment posted healthy growth even as the skincare sub-segment was hit by the delayed winter. The management also pointed out that its soup portfolio was aided by falling palm oil prices, as the company passed on the benefit of lower prices to customers.    

Gross margins improve sequentially on lower inflation 

The firm’s gross margins have contracted by 460 bps YoY to 47.5% but grew sequentially by 170 bps. The volatility in margins is due to the sensitivity of the company’s margins to commodity prices. The improvement in margins on a QoQ basis is mainly due to declining inflation rates.

According to the management, net material inflation in Q2FY23 was at 22%, and price increases were at 12%, making the price versus cost gap 10%. In Q3, net material inflation lowered to 18% and pricing was at 11%, bringing down the price versus cost deficit to 7%.

HUL plans to depend less on a decline in inflation to improve its margins. It is focusing on  premiumisation, scale leverage and market development.

Volume continues to grow, focus on rural demand

As rural demand sees gradual improvement and urban demand gains traction, underlying volume grew by 5%. This growth rate is better than the last quarter and the same period last year. Whereas, the industry’s volume growth rate has declined by 4% in Q3FY23.

This slight improvement in volumes is most likely due to rural demand finally seeing some signs of recovery. According to Sanjiv Mehta, “Despite high inflation, people in rural areas, when it comes to real rupee prices, have been spending more than last year, and certainly on our brands”.

The management believes that a meaningful recovery in volumes is contingent upon the rural demand improving. It believes that rural consumer spending may start to rise in the near term due to lower inflation, strong winter crop sowing and signs of pickup in farm incomes.

Advertising spending increases, anticipating demand improvement  

The management has increased advertising spending as announced in the past quarter. A&P spending finally grew on a QoQ basis after two consecutive quarters of decline, although it remains lower on a YoY basis. It looks like the company is more optimistic about the demand picking up and inflation bottoming out.

Over the past few quarters, most FMCG companies have been lowering the advertisement spends as demand was lukewarm. With HUL increasing A&P spending as a percentage of revenue, it will be interesting to see whether other FMCG giants will follow suit.

Board approves increasing royalty & central services fee by 80 bps to 3.45%

Even though HUL posted a set of healthy numbers in Q3, investors have  not been upbeat about the stock. This is mostly due to the company’s board approving the proposal to enter into a new agreement with Unilever for the provision of technology, trademark licenses and services. Under the new agreement, the royalty and central services fee will increase by 80 bps over a three-year period to 3.45% of revenue. The agreement will come into effect from February 1, for a period of five years.

While many view this as an increase in expenses, the management believes it will not affect growth prospects. It pointed out that this will enable the company to have continued access to Unilever’s technology and R&D, helping improve its product portfolio.

Motilal Oswal concurs that  this rise in royalty fees will not hamper growth and the benefits HUL will receive from its parent company makes up for it. The brokerage also points out that a fee of 3.45% is still lower compared to peers like Nestle India and Colgate Palmolive, which are close to 5%.  

Inflation expected to soften further; management optimistic

Trendlyne’s Forecaster estimates HUL's annual revenue to grow 13.5% YoY in FY23. The management is optimistic about the near-term prospects for the company. The company expects commodity prices to soften further and is unlikely to increase any time soon. They believe this bodes well for the FMCG industry and will lead to an improvement in consumer demand.

However, the management expects growth to be price-led in the near-to-medium term, although the level of price growth will start to decline gradually. The company also expects rural demand to start improving.

Despite this positivity, the company is sensitive to external factors such as inflation and changes in government schemes in rural India. If these macroeconomic factors do not pan out the way HUL expects, the recovery in consumer demand may be delayed. 

This analysis by Trendlyne is meant for investor education - to help understand companies and make informed investment decisions on their own. It should not be considered an investment recommendation.

After taking the hit from inflationary pressures and European unrest for the past few quarters, top-tier IT companies’ saw a lift in Q3. They delivered a healthy performance in the seasonally weak quarter of Q3FY23, largely beating the street’s expectations.

Due to the impact of higher furloughs and lesser working days, analysts at HDFC Securities had expected the IT giants to have a soft quarter. But the big four IT firms performed better than expected. Tata Consultancy Services (TCS), Infosys and HCL Technologies (HCL Tech) beat Trendlyne’s Forecaster revenue estimates in Q3.

And it looks like growth came from across the board - across markets and industries. Salil Parekh, CEO and Managing Director of Infosys, said, “This performance was in a seasonally weak quarter and amid a changing global economy. We continue to gain market share. Growth in Q3 was broad-based, with most industries and geographies growing in double digits in constant currency.”

The companies are confident about their medium-term growth outlook, and anticipate healthy traction in order bookings. C Vijaykumar, CEO and Managing Director of HCL Technologies, said “We remain positive on medium-term growth, with confidence generated by good bookings and pipeline across every segment.”

The stocks of these IT giants seem to be making up for lost ground, as they have gained over the past quarter.  

Except for Infosys, all other top-tier IT firms outperformed the Nifty 50 and Nifty IT over the past quarter till January 23, with HCL Tech giving the best performance. 

The companies are trading at expensive valuations, indicated by their low valuation scores. HCL Tech and Infosys have high durability scores, and TCS and HCL Tech have good momentum scores.

Healthy deal wins prop up revenue growth

Although market conditions have remained unchanged since the past quarter, robust demand for cloud services, healthy deal wins and market share gains through vendor consolidation fuelled revenue growth for the IT giants. 

HCL Tech leads the pack with its revenue growing 8.2% QoQ, driven by the HCL Software segment (formerly known as the products & platform segment). It has risen 30.5% QoQ in constant currency (CC) terms and contributed 12.2% to total revenue. The IT & business services segment, which contributes 71.7% to the revenue, grew 2.1% QoQ in CC. The management has lowered the growth guidance of IT services for FY23 to 16-16.5% YoY in CC from 16-17%.

According to HCL’s management, the business verticals of life sciences & healthcare, manufacturing and telecom led revenue growth in Q3. On the other hand, its financial services and retail verticals contracted sequentially.

TCS comes in second with a growth rate of 5.3% QoQ,  driven by regional markets, life sciences, manufacturing, and retail & consumer business verticals. North American and UK markets led its revenue expansion.

All tier-1 IT companies have indicated relatively moderate growth in their biggest vertical–banking, financial services and insurance (BFSI). Management of HCL Tech and Infosys pointed out that the Financial Services segment was impacted by furloughs.

Infosys’ revenue has increased 4.9% QoQ on the back of its energy, manufacturing and life sciences business verticals. For Wipro the 3.1% QoQ revenue growth was led by its health and energy business verticals. For both companies, revenue growth was led by their Europe market segment.

Europe was the largest contributor of growth for the IT giants, barring TCS. This is despite the ongoing energy crisis there, which is leading to a fall in non-discretionary tech spending and a slowdown in decision-making. HCL Tech’s management attributes this robust performance in Europe to the execution of a large telecom deal it won a while back. But the company is not upbeat about growth from the region going forward. A noticeable share of new deals is now coming from North America.

Operational efficiencies drive better-than-expected profit growth

All IT majors have seen their net profits grow sequentially in Q3FY23. This was mostly led by cost optimisations and operational efficiencies. Except for TCS, all other IT giants beat the street’s expectations. Infosys, HCL Tech and Wipro beat Trendlyne’s Forecaster net profit estimates by 1.9%, 0.1% and 4.5% respectively.

HCL Tech’s net profit increased by the largest margin, growing 17.4% QoQ to Rs 4,096. It was followed by Wipro’s 14.8% QoQ growth.

Double-digit revenue growth expected in FY23, Infosys raises revenue growth guidance

Trendlyne’s Forecaster estimates double-digit growth in annual revenue for all top-tier IT companies in FY23. Among the four, Infosys’ revenue is predicted to witness the highest growth rate, rising 17.8% YoY. Like the previous quarter, this estimate is higher than the company’s guidance of 16-16.5% YoY in constant currency. The management has raised its revenue guidance for FY23 to 16-16.5% YoY in CC from 15-16% YoY in CC.

TCS is expected to see revenue growth of 14.8% YoY. The management anticipates the key markets of North America and the UK to continue driving growth.

Despite unfavourable market conditions, all the companies seem to be optimistic over the medium term. They expect cloud services and cost optimisation programs, along with rising vendor consolidation, to keep demand healthy. However, they see the impact of the macro headwinds to be greater in Europe, than in North America, thus lowering client spending from the region.

Forex gains and lower subcontractor costs aid margin improvement

EBIT margins continue to rise sequentially for the IT giants, with the exception of Infosys. Its margin has remained flat QoQ, mainly due to higher selling, general & administrative expenses and the impact of furloughs and seasonality. These margin pressures offset the benefits of lower subcontractor costs and forex gains. Despite margins remaining flat, the management has maintained its EBIT margin guidance of 21-22% for FY23.

Across the board, the big four have witnessed a dip in margin pressures on the back of favourable currency movement, improved operational efficiency, lower subcontractor costs, declining attrition rates, pyramid optimisations and higher realisations.

HCL Tech’s EBIT margin improved by 170 bps QoQ, the highest among its peers. The firm’s margin was boosted by HCL Software’s robust performance. However, the management has lowered its margin guidance to 18-18.5% from 18-19% for FY23, as it expects revenue growth for the segment to be weak in Q4 on account of seasonality.

Wipro’s EBIT margin expanded by an impressive 120 bps QoQ to 16.3%, despite record-high promotions and wage hikes in Q3. The management attributes this to effective reductions in cost structure, lower attrition and automation-led efficiency.

Attrition rates fall across the board

The industry trend of moderating attrition rates was witnessed by all top-tier IT software companies in Q3. Infosys’ attrition rates dropped the most, 280 bps QoQ to 24.3%. As the labour market cools off and supply-side pressures subside, all the companies expect attrition rates to fall further. The management of Infosys expects to lower its attrition rate to below 20% in the medium term.

TCS, for the first time in six consecutive quarters, saw its attrition fall. Although the decline is only 20 bps QoQ, the management is confident that it will fall further. On the other hand, HCL Tech and Wipro’s attrition rates fell sharply on a sequential basis, 210 bps and 180 bps QoQ respectively. Only Wipro and Infosys have managed to lower their attrition rates on a YoY basis.

All the IT giants are expecting attrition rates to decline further in the coming quarters. They expect this to be a key aspect in improving margins.

Employee costs and subcontractor costs fall as supply-side pressures ease

Wipro’s employee costs as a percentage of revenue have fallen 230 bps QoQ, the most among its peers. Even though the company carried out promotions and wage hikes in Q3, it managed to lower its employee costs. This was mostly due to better supply chain management, lower attritions and also having many freshers in its pyramid.

Compared to the previous quarters, hiring among the big four has slowed down. This comes as the companies focus on improving utilisations and employee productivity. As wage expectations across the industry are declining, employee costs will continue to moderate and hiring trends will likely go back to pre-covid levels in FY24.

Consequently, subcontractor costs have fallen for the second consecutive quarter for all top-tier IT companies. Infosys sees the biggest drop in subcontractor costs, 140 bps QoQ. Wipro comes in second with a drop of 60 bps QoQ. As IT companies are able to retain their employees better, subcontractor costs are expected to further decline in the coming quarters.

Deal wins robust despite macro headwinds

Despite the weak macroeconomic conditions in key markets, all the IT companies in focus have had robust traction in new deal wins. The pick up in orders pertaining to cloud services and cost optimisations has offset the slowdown in deal conversions and discretionary spending.

Infosys’ total contract value (TCV) expanded by 22.2% QoQ to $3.3 billion on the back of strong traction in vendor consolidation and cost-takeout deals in Q3FY23. It won 36 large deals, of which 36% were net new. The management indicates that the order pipeline remains robust with a high focus on cost optimisation deals.

HCL Tech’s TCV was in line with the management’s target of $2-2.5 billion a quarter, backed by an increase in vendor consolidation and cost-takeout deals. The company saw a weakness in Europe, but the momentum remained strong in the US. The company’s TCV was nearly flat sequentially but rose 10% YoY. TCS saw an uptick in vendor consolidation deals, mostly in the verticals of BFSI, healthcare and telecom. Its TCV of $7.8 billion fell QoQ by 3.7% but rose 2.6% YoY.

Wipro’s TCV came in at $4.3 billion, up 26% YoY, with large deals worth over $1 billion. The company expects deal conversions to improve down the line, given its strong order backlog.

Healthy medium-term growth outlook but caution to remain

Although headwinds in the key markets of North America and Europe continue to persist, the management of the top-tier IT firms are optimistic over the medium-to-long term. They expect a slowdown in some verticals but see demand for cloud services and other non-discretionary services to remain strong.

With their order pipelines gaining traction and attrition rates falling, these companies expect an improvement in margins.

However, top-tier IT firms are not out of the woods yet as caution around IT spending still remains across all markets. Given the economic uncertainty, investors should keep in mind that these IT giants are trading at expensive valuations.

This analysis by Trendlyne is meant for investor education - to help understand companies and make informed investment decisions on their own. It should not be considered an investment recommendation.