IT Sector: $ revenue growth to fall further in FY16

Currency impact, slower growth in select verticals to result in 9% dollar revenue growth in FY16

India’s information technology (IT) sector appears to be headed for another tough year. Slowing growth and currency weakness have hurt sales and profit growth of the top four IT companies. On one hand, repeat business from the existing clients is not coming easily. On the other, companies are still in the process of building digital capabilities, where future growth will come from. Investors will have to reconcile to a slower growth trajectory, which cannot justify the premium valuations. If companies wish to command these, they need to improve capital allocation such that return on equity improve.

Structurally, the sector’s dollar revenue growth has been coming down and is expected to decline further this year. In FY15, dollar revenues of the top four IT companies grew 11 per cent, against 13 per cent in FY14. Barclays expects this to decline to nine per cent in this year. Gartner expects revenue to contract 0.6 per cent over a year to $942 billion in 2015. Nasscom, too, expects the sector’s revenue growth to be 13 per cent in FY16, against the 16-18 per cent  annually in FY11-12.

While currency headwinds impacted revenue growth to some extent, the slowdown in energy and telecom led to revenue growth declining 0.5 per cent sequentially in the March quarter. Tata Consultancy Services (TCS) took a hit due to issues in the telecom, energy and insurance verticals. Infosys witnessed severe pricing pressure, which hurt revenue growth. However, over 2015-18, deals worth $147 billion are coming for renewal and Indian players can look at improving market share by participating in the rebids, which would provide a $29 billion market for the top five players.

However, pressure on revenue growth would continue for the sector, as the dollar has appreciated seven per cent against the euro, three per cent against the pound and five per cent against the Australian dollar. Gartner expects dollar strength to impact global IT spending by 310 basis points in 2015. Operating margins of the sector declined sharply over the past three quarters. Reliance Securities expects Infosys margins to be impacted in the June quarter due to wages and higher visa costs but is building in margin of 25.9 per cent for FY16-17. Though TCS expects to maintain margins within the 26-28 per cent band, analysts are building in margins closer to the lower end of the band for FY16-17. Tech Mahindra's margins would take longer to recover.