Mid-caps in IT service sector show strong growth in digital business in Q4

Mid-caps in the information technology (IT) service sector had a sweet run in the March quarter of FY18 with most of these managing to deliver better-than-expected numbers backed by strong growth in their digital business and a robust deal pipeline.

The likes of Persistent, Zensar and Larsen & Toubro Infotech (LTI) saw digital deals bringing in maximum momentum. 

LTI posted 42 per cent year-on-year (y-o-y) growth of their digital business while Zensar (despite some drag from legacy services) had shown strong digital penetration among its top 20 clients. Bengaluru-based midsize IT firm Mindtree had 45 per cent of its total business coming in from the digital vertical. 

“Except for Persistent, which had already warned about the impact on intellectual property (IP) revenue, most companies like LTI, LTTS (L&T Technology Services), NIIT Technologies, Mindtree and Cyient have shown good performance in the quarter. On the digital front, these companies are adding large clients almost at pace with their large-cap peers,” said Urmil Shah, equity analyst at IDBI Securities.

Most mid-caps have also made progress on new client wins, led by LTI which added two $50-million clients during the quarter, and Mphasis, which acquired large clients through the year while also increasing its footprint in Europe. 

“Clients are looking for the ability to declutter the technology and change the operational technology. In the sectors where we operate like oil and gas or manufacturing, the domain expertise of the parent L&T, has helped us to build clear differentiation in terms of the services we provide,” said LTI Chief Executive Officer and Managing Director Sanjay Jalona, after Q4 results were declared.

During the quarter, LTTS also added large deals from clients, such as Exxon Mobil and Covestro, while the company was quite bullish on the deal pipeline. The digital business of NIIT grew 37 per cent over the year.

Pune-based Persistent Systems witnessed a sequential drag on IP revenue and yet witnessed 43 per cent growth on y-o-y basis in its digital business. “The partners we work with follow calendar year and the calendar year projections are in line with expected growth. The dip this quarter is thus one-off and we expect to recoup a large part of this decline in the next two or three quarters,” said Sunil Sapre, additional director (executive member) and chief financial officer, Persistent. 

For some of the companies, margins have remained a concern. Notably, Cyient was impacted by a slowdown in its core IT business of almost 50 basis points (bps) quarter on quarter (q-o-q), noted HDFC Securities. The company’s operating margin also contracted by almost 190 bps due to lower utilisation during the quarter, which is likely to correct with demands coming back in the defence and aerospace sectors.

The drop in utilisation rates, largely an offshoot of changing requirements of digital business, has also impacted margins of mid-caps as well. 

Persistent said it improved margins on the back of 134 bps sequential rise in utilisation levels by reducing headcount and improving gross margins across digital services. 

Zensar witnessed an impact of 100 bps of the total 124 bps contraction sequentially on margins due to reduced utilisation. 

Hexaware is another company that witnessed a small impact of about 20 bps on operating margins due to increased investment in localisation and senior talent management especially for their European business during this quarter.