The Q3FY24 earnings from the big four IT firms — Tata Consultancy Services (TCS), Infosys, HCL Technologies (HCL Tech) and Wipro — mirror a global slowdown in IT spending. This trend comes as a surprise to no one, since Indian IT companies have been flagging that risk over the last couple of quarters. The post-Covid era has been a difficult readjustment as clients pulled back from ambitious digital projects, reduced discretionary expenses and prioritized efforts with immediate returns on investment. 

This trend has been especially evident in the banking and financial services segment, which was hit hard by higher interest rates, liquidity tightening, and delayed decision-making. On the upside, some sectors like utilities and manufacturing have ramped up their IT spending. 

Still, as the industry braces for Q4FY24, there's a cautious optimism in the air. K Krithivasan, CEO of TCS, said, “The demand environment in Q3 has not deteriorated further compared to Q2. While some projects are being postponed, we are still adding more business than we are losing.”

Another key takeaway from this earnings season is the firms’ lower attrition rates and negative employee additions. Major IT firms have also narrowed their revenue guidance for Q4FY24. Infosys revised its guidance from 1-2.5% to 1.5 - 2%, and Wipro’s estimates moved from -3.5-1.5% to -1.5-0.5%.

And despite a cautious outlook for FY24, these IT giants remain positive about their medium-term prospects due to a healthy deal pipeline. 

HCL Tech beats profit estimates, Wipro disappoints  

In the face of current challenges in the IT sector, Indian software companies have been muted in their Q3FY24 performance. Wipro, Infosys and HCL Tech have outperformed benchmark indices over the past month, with the Nifty IT index rising by 6% and the Nifty 50 by 1.3%. 

Only TCS underperforms the Nifty IT index

TCS and Infosys did not fare well. Their profits declined QoQ and missed Forecaster estimates by the biggest margin compared to their peers.  

TCS and Infosys miss Forecaster’s profit estimates

In contrast, HCL Tech beat revenue estimates by 1.3% and profit estimates by 5.6%.  Wipro’s revenue and profit growth were in line with estimates, despite a weak performance.  

BFSI slowdown dampens growth, Wipro underperforms peers

The IT sector is seeing a cutdown in spending by BFSI clients. Banking clients are focusing on cost optimization, giving approvals for business-critical initiatives only. However, sectors like utilities & energy, retail, automobile and telecom are increasing their IT budgets. 

The US in particular has scaled back IT spending, while Europe (including the UK) and the Middle East are ramping up their investments in IT projects. Indian IT majors are also exploring new markets in Africa and Asia to reduce their dependence on the US.

HCL Tech saw 6.6% QoQ growth, outperforming TCS’ more tepid increase. Infosys saw its revenue consolidate, impacted by the termination of a $1.5 billion project during the quarter. 

Wipro trailed its peers with a 4.6% YoY revenue drop. Its BFSI segment, which contributes nearly 34% of its revenue, declined by 5.9% YoY.

However, Wipro is optimistic about FY25. CEO and MD Thierry Delaporte said, “We are seeing a resurgence in discretionary spending in the market. This is something we couldn’t have said a quarter or two ago.” However, the optimism is dampened by recent high-level exits, including of CFO Jatin Dalal last quarter and Chief Growth Officer Stephanie Trautman’. 

Revenue growth moderates as tech spending remains weak

Seasonal furloughs affect profitability

Seasonal furloughs have notably affected the IT sector's profitability, with TCS experiencing a significant margin reduction of 80 bps. Wage hikes, tepid revenue streams, and higher third-party expenses added to the contraction of margins. Wipro, dealing with a cybersecurity incident, also saw its margins shrink by 60 bps.

HCL Tech leads in QoQ profit growth

In contrast, HCL Tech outperformed its peers with a 15% QoQ increase in net profit. While Wipro’s bottom line grew by around 4%, TCS and Infosys reported declines in net profits. 

Concerns rise over slowdown in new orders

Typically, Q3 is a dull quarter as most of the decision-making gets postponed to Q4 due to furloughs. After a blockbuster Q2, deal momentum has slowed down, with clients reducing discretionary spending and prioritising high-return projects.

During this period, Infosys also lost a major contract worth around $1.5 billion in its digital solutions and AI vertical. At the same time, Wipro gained new orders from its recent acquisitions, including Capco, Rizing and Designit. TCS secured deal wins through vendor consolidation, while HCL Tech’s deal wins were driven by the telecommunications and media segment.

Deal pipeline lower for large IT firms in Q3FY24

TCS remains bullish about its growth in India and expects a 23% increase in its India business in FY25. HCL Tech is optimistic about its non-BFSI segments, while Infosys is exploring other verticals like generative AI and engineering R&D. Wipro is banking on consulting to bounce back as the global economy picks up pace.

Lower attrition rate and negative employee additions point to tight revenue streams  

The trend of lower attrition rates continued in Q3FY24. As firms face revenue constraints, they are reluctant to offer higher salaries to new hires. Instead, they are working on talent retention through incentives rather than recruiting new employees at higher packages and training them. 

Significant QoQ drop in attrition rate

This quarter saw a notable drop in attrition rates across most firms, with a decline of around 150 bps QoQ. There has also been a trend of negative employee additions, with HCL Tech being the exception. Firms like Infosys and Wipro have even declined campus placements in FY24. 

HCL tech sees positive employee addition in Q3FY24

The slowdown in new deal wins has impacted attrition rates and hiring trends. While lower attrition rates and negative additions can benefit margins, they also highlight the underlying problem of constrained revenue streams in the industry.

Firms stress margin expansion and cost optimization measures

In response to a subdued topline, IT firms are working towards improving EBIT margins. Despite the challenges of seasonal furloughs and macro headwinds, margin expansion has been welcome news. Higher resource utilisation, lower subcontractor costs, an improved on-site mix, and cost optimisation measures have boosted margins. A stronger US dollar has also helped offset the impact of the top-line slowdown.

HCL Tech sees expansion in its EBIT margins

HCL Tech leads in margin expansion with an increase of 150 bps. The engineering R&D division has been a key driver of this growth, although, like the rest of the industry, its consulting division has faced challenges.

Looking ahead, companies expect margins to remain range-bound in FY24, with room for marginal improvement. Infosys is maintaining its EBIT margin guidance at 20-22%, while Motilal Oswal projects HCL Tech margins to expand by another 50 bps.

Navigating short-term challenges with an eye on a brighter FY25

The IT industry is currently grappling with stress on the top line, a trend expected to persist for the next few quarters until rate cuts begin. The banking and financial services sector, a key growth driver, is expected to regain momentum only after these rate cuts are implemented.

According to TCS CEO and MD K Krithivasan, "The optimism around interest rates has not eased uncertainty in decision-making. Sentiments remain unchanged, so it’s premature to predict a recovery by Q4."

In response, firms have been shifting focus from the traditional BFSI sector to new verticals like utilities, telecom, automobile, retail and manufacturing. They are also tapping into newer markets in Asia, Africa and the Middle East for projects.

While the trend may continue for another quarter, there are signs of green shoots amid the gloom. Technologies such as automation and AI are gaining traction, and companies are increasing investments in training their workforce in these areas. FY25 is expected to see a significant upturn in these sectors, after the speed bumps of FY24.

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