Like always, the street and investors waited for Tata Consultancy Services' Q4FY22 results to get a sense of where the IT services space will end up post the March quarter’s numbers.. Ahead of Infosys’ and the rest of the IT services companies’ results, the Nifty IT index is trending downwards.

Although TCS managed to beat Trendlyne Forecaster’s revenue and profit consensus estimates marginally, this didn’t cheer up the street much as the Nifty IT index continued its downward trajectory that began on Thursday. The concern seems to stem from TCS’ high attrition levels. TCS’ trailing-twelve month attrition was at 17.4%, its highest ever. 

Technology research firm ISG in a recent call alluded to the fact that attrition is here to stay and is starting to bite. Competition for engineering talent has grown fierce, and it’s likely that high attrition levels will show up across IT services companies, like in the previous quarter. 

Companies are facing difficulties in staffing projects, affecting the entire industry’s ability to ensure smooth transitions  in projects and in running services, according to ISG analysts. 

Margins might shrink, leading to PE compression

ICICI Securities in a recent report said that it anticipates PE ratios will contract going into FY23. The brokerage feels the exuberance in the stock prices of Indian IT services companies was rightly based on sustained demand for digital services, and companies across industries needing to upgrade their technology stacks.

However, in India, this has also led to a surge in demand for talent with the requisite skills. The shortage of people to man projects has led to many companies going to colleges in droves to create a bench strength that will help them train talent in-house rather than hiring expensive manpower.

This sentiment was echoed by ISG as well, which said there were an average 3 lakh openings in India for open positions at Indian technology firms in Q4FY22. And IT services led the growth in these openings. To get a sense of how big this problem really is, here is a sample—TCS hired a little over 1,03,000 people in FY22 on a net basis.

This is set to impact the operating margin of Indian IT services companies. This is how the margin trajectory looks like for the top four listed Indian IT services companies right now.

There is also a fear that many companies that were spending a lot to upgrade their technology stack, might hold back due to the surge in commodity prices that is causing inflation across the board. ISG and ICICI Securities anticipate that the impact of inflation in the hands of end-consumers could even impact the ability of companies across industries to undertake discretionary technology spending.

Inflation is pervasive across the world, even in the US and Europe, which might lead to companies trimming their technology spending in 2022. So much so that research firm Gartner had to cut its IT spending growth forecast in April to 4% over 2021 from the 5.1% it announced earlier in January.

For investors, it might be time to reassess their persistent faith in the Indian IT services story, which has earned them high returns over the past several years. Indian companies will take a few more quarters to rejig their employee cost pyramid as the fresher intake ramps up. Till then, higher margins will have to wait, despite a robust demand environment.