Discretionary spends, market share gains in digital to lift IT growth

Expectations for Dec quarter remain muted but March onwards looks better

Improving economic outlook in the US and other key countries, uptick in discretionary spends and market share gains in the digital segment are expected to improve the growth momentum for Indian information technology (IT) majors. 

While the Indian IT firms saw their earnings revised downwards last year by as much as 15 per cent, as the improvement in key sectors such as banking, financial services and insurance (BFSI) did not come through, better growth prospects could help them reverse this trend in earnings. 

Analysts at Edelweiss expect the outlook for IT companies to improve on the back of better growth in the US and Europe. Given the improving profitability in the BFSI sector and demand scenario, the brokerage expects a jump in discretionary spends by clients of these firms. Analysts at CLSA, too, expect strong growth in discretionary spends in select verticals (industries), such as insurance, manufacturing, energy, travel and health care.

The other trigger would be market share gains in the digital space, which currently accounts for 20 per cent of the revenue pie of Indian IT companies. Infosys and Wipro are at the top, with 25 per cent from this segment. Further, a sustained increase in the number and scale of digital transformation deals with clients preferring larger companies for execution should translate to higher growth and market share gains for the domestic IT biggies. 

The sector also faces some headwinds. One of these is insourcing or clients using their internal teams for IT projects. This, according to analysts, will remain a risk in 2018, as clients, especially in the BFSI and retail segments, have increased their in-house IT projects, compared to other verticals. The strengthening of the rupee against the dollar, pricing pressure, given the commodity nature of legacy offerings, wage hikes and increase in onsite staff, given H1-B issues could lead to pressure on margins. 

In the near term, IT stocks could see some pressure, given the muted performance expected in the December quarter due to the holiday season and lack of currency tailwinds. However, much of it is also known. The top five Indian IT companies are expected to post revenue growth of under three per cent in dollar terms on a sequential basis in the December quarter. 

Among the top companies, most analysts have a ‘buy’ rating on HCL Technologies, given the exposure to the high growth engineering and R&D segments, improving outlook for infrastructure management and acquisitions-led growth. Tech Mahindra is another key pick, on the back of a recovery in telecom, growth in enterprise vertical and expectations of operating profit margin expansion.