The Indian investing community had high hopes for Nifty 50 reaching the 20,000 mark last week, but Infosys' results caused a pullback just before this milestone.
Indian IT 's earnings season began on a cautious note. TCS, a key player in the industry, noted that global macro headwinds "are affecting revenue and margins". Morgan Stanley had previously predicted a modest performance for Indian tech in Q1FY24, with improvement in the second half of FY24.
India’s software services has been a driving force in India's growth, contributing nearly 19% of overall exports and growing by 20% in FY23. However, the Q1FY24 earnings season has been underwhelming - the big four IT firms (TCS, Infosys, Wipro and HCL Technologies) reported tepid earnings and lower revenue guidance. The management is focusing on cost-cutting measures amid the slowdown.
Nifty IT rose by just 3% in the April-June 2023 quarter as investors re-evaluated what used to be a booming sector. The broader Nifty 50 rose by around 11% in the same period, so IT is now a clear laggard, as recessionary pressures, global financial turmoil, spending cuts, and the rise of technologies like AI raise questions about the growth outlook.
In this week’s Analyticks:
- Losing Momentum?: Global headwinds slow IT sector growth
- Winners and losers screener: IT stocks which outperformed and underperformed Trendlyne's Forecaster estimates in Q1FY24
Let’s get into it.
IT firms cut down their revenue guidance
The earnings season for the majority of Indian IT firms was not celebratory and was quite a mixed bag, with TCS and HCL recording a moderate performance, while Infosys' and Wipro's weak numbers underlined the slowdown. A major highlight of the season has been the cut in revenue guidance. For instance, Infosys revised its FY24 revenue guidance from its eariler estimate of 4-7% constant currency growth to 1-3.5%.
Commenting on the lower guidance, Infosys CEO Salil Parekh said, “In the short term, we see some clients reducing or even stopping work on transformational programs and projects. This is especially visible in financial services, mortgages, asset management, investment banking, payments, telecom, high-tech, and parts of retail.”
While Wipro hinted at -2% to 1% revenue guidance, HCL and TCS pegged their numbers at around 5% to 7%. A key driver for the lower revenue guidance has been the slowdown in the global BFSI (Banking, Financial Services and Insurance) sector. This vertical contributes nearly 30% of IT services revenue, and has seen a spending cut in discretionary tech services.
Except for HCL, all other firms have seen a drop in revenue from BFSI clients. Indian IT has in the meantime, diversified its exposure to retail, pharma, auto, and other sectors. The BFSI share has significantly decreased from the 40% it had three years ago.
The telecom sector has also seen its share of revenue drop. On the upside, the retail, energy and manufacturing sectors are moving towards technology adoption post-pandemic.
Slower decision-making clogs up deal pipeline for tech companies
As interest rates rose, the collapse of Silicon Valley Bank in the US and Credit Suisse in Europe spread cracks across the US and European banking sector. Banks and finance companies have decided to wait out the storm and delay new IT spending.
While large deals are still coming through, they are taking longer to finalize due to decision-making getting pushed all the way up to the CEOs and CTOs in client companies.
When interest rates were low and money was cheap, a lot of tech moonshot projects were getting funded by customers. Now that has changed. According to CEO of TCS, K Krithivasan, “Macro uncertainties have made clients more cautious. They are taking a month to month approach, and that means low visibility on their future spending. We will prioritize projects that are business-critical and offer faster ROI realization. Long-running discretionary projects are now coming back with reduced scope or pace.”
While the deal pipeline is holding steady, the conversion rate for new deals has decreased. So order inflow will likely slow down going forward.
The new deals already signed might see execution delays. However, regular spending on maintenance projects is expected to continue at the previous pace. It is discretionary spending, which involves smaller budgets and faster turnaround times, that is seeing the biggest cuts.
Retaining talent becomes key, as hiring slows down
The pressure on the sector's top-line growth has pushed the management to focus on margins. However, the margins of the IT pack have fallen since Q4FY23. The recent salary hikes have offset some of the gains from lower subcontractor costs and higher resource utilisation. According to TCS CFO Samir Seksaria, salary hikes have resulted in a 200 bps impact on the EBIT margins.
Lower attrition has controlled the decline in margins for the IT pack. However, the attrition rate continues to be above pre-pandemic levels of 10 -12%. Companies are responding by trying to retain and promote their new talent pool instead of hiring external replacements. This has led to a higher utilisation of the bench pool and lower net additions of employees.
If the attrition rate falls by another 300 bps, IT firms could see a margin expansion in the range of 75-100 bps. Currently, the net additions of employees for large IT firms have been negative or marginally positive.
The impact of the AI revolution is still undecided
With the rise of Chat GPT and Google Bard, generative AI has become the buzzword in IT circles.
But there are many uncertainties around AI right now - clients are unsure about how to use it. Client engagements for AI projects have revealed ever-changing requirements, and clarity is lacking on how to integrate AI into business processes. The high error rates, and the 'hallucinations' of chatbots, have made customers cautious about adoption. Indian IT firms are investing into in-house pilot projects to get a better understanding of AI's nuances and possibilities.
However, Infosys CEO Salil Parekh was clear on the promise, saying, “AI will not replace human jobs but complement them, and Infosys has seen a 10-30% productivity improvement using AI internally and with clients.”
Recognizing the significance of AI, Wipro has committed $1 billion to building AI technology, including acquiring established AI firms. Wipro CEO Thierry Delaporte believes that, “AI is a fast-moving field. Especially with the emergence of generative AI, we expect a shift in all industries. It’s meant to empower our talent pool and help clients”.
TCS is training 50,000 employees under its AI program, while Wipro has pledged to train its entire workforce of 2,50,000 employees in generative AI.
Overall, IT firms are focusing on steadying their revenue and margin growth amid the global slowdown. Deals are still happening, and there are no immediate threats from disruptive AI. The Indian IT sector is for now, well-equipped to handle the slowdown, so long as it's temporary.
Tech winners and losers screener: IT stocks which outperformed and underperformed Trendlyne's Forecaster estimates in Q1FY24
As the software & services sector releases its Q1FY24 results, we take a look at how these companies have performed compared to their revenue and net profit estimates. This screener shows tech stocks that have outperformed and underperformed analyst estimates.
Notable stocks in the screener are Infosys, Wipro, HCL Technologies, Tata Consultancy Services (TCS), LTIMindtree, Coforge, Tanla Platforms, IndiaMart InterMesh and One97 Communications.
Tanla Platforms’ net profit grew by 12.6% QoQ to Rs 135.4 crore in Q1FY24, beating Trendlyne’s Forecaster estimates by 16.2%. Its revenue also rose 9.3% YoY to Rs 911.1 crore, surpassing estimates by 7.6%. The company’s revenue grew on the back of the enterprise and platform segments, aided by a recovery in transaction volumes and an international long-distance (ILD) rate hike.
Tata Consultancy Services is the only big four tech giant to beat Forecaster estimates for net profit, despite a 2.8% QoQ fall to Rs 11,047 crore in Q1FY24. However, revenue remains flat at Rs 59,381 crore, in line with estimates. This was caused by muted growth in the BFSI and retail segments, combined with delays in non-critical projects.
HCL Technologies missed the Forecaster estimates for revenue and net profit by the largest margin among the big four in Q1FY24. Its net profit declined 11.3% QoQ to Rs 3,534 crore, missing Forecaster estimates by 8.3%. Similarly, revenue fell by 1.5% QoQ to Rs 26,640 crore, missing Forecaster estimates by 1.9%. This decline can be attributed to the slowdown in revenue from the technology and telecommunications segments due to a cut in discretionary spending and decision delays.
You can find more screeners here.
