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.