Results preview: Margin woes may not ease for IT services companies

Management commentary amid a 'Lehman Brothers situation' in Europe will be key

Alarm bells are already ringing for the IT sector. Earlier a fear of recession was impacting the sentiment and now questions are being raised if the crisis in Credit Suisse and Deutsche Bank is another Lehman Brothers situation. Hence, management commentaries on demand in the second half of FY23 will be closely looked into.

“Whether it’s a Lehman Brothers moment or not, only time will tell. But, in general, Europe BFSI will be a challenging space for IT companies amid a recession in the EU and currency weakness,” said an analyst.

For Q2FY23, revenue growth is expected to be resilient for tier-1 IT services firms. Analysts expect constant currency sequential revenue growth to be in the range of 2.3-5 per cent. Despite growth, margins are expected to be under pressure as supply-side issues persist. 

More importantly, total contract value (TCV) would be softer as no large deals have been signed during the quarter, analysts said.

The results of Indian IT services companies will start trickling in from October 10; Tata Consultancy Services (TCS) will the first company to announce its numbers. Wipro and HCL Tech will announce their numbers on October 12, followed by Infosys on October 13.

Analysts are expecting that the disconnect between the macro environment and the management sentiment will taper down in Q2. “We expect a shift in the management tone from ‘continued strength in demand’ to focus on return on investment and cost optimisation by clients, resulting in normalisation of demand,” said Aniket Pande and Aditi Patil of ICICI Securities in their report.

The bad news that will continue to impact the sector performance will be tightening margins. 

On a positive note, analysts expect that attrition should start to come down as the macro-environment gets impacted.

“Margin headwinds continue — high cost to backfill attrition, increase in travel, and back-to-office costs, among others. Some of the pressure points, especially on talent, will ease in the subsequent quarters. For the September 2022 quarter, the headwinds result from wage revisions (Infosys, Wipro, HCL Tech and Tech Mahindra), and higher travel costs,” said a Kotak Institutional Equities report.

It added that margins will see an improvement as headwinds will be absorbed on a sequential basis through an increase in utilisation, rupee depreciation and cost control. “However, the Ebit margin will be impacted on a YoY basis,” said the Kotak report. The other worry is the depreciation of currencies versus the dollar, especially the euro and the pound. At spot currency rates, euro- and pound-denominated businesses will take a 300-400-basis point margin hit. The hit can be amplified in long-duration contracts with locked-in rates (TCS and HCL Tech have a fair number of such contracts), said the Kotak report. Analysts are confident about demand as Accenture results show one of its strongest quarters in the outsourcing business and this augurs well for Indian players.               

Watch Out For

• Hiring momentum/attrition rates; Accenture headcount addition has remained soft
• Commentary on deal pipeline and any sign of a slowdown in deal conversion, TCV
• Pricing and demand for H2FY23
• Margin outlook amid wage inflation and slowing revenue growth