Retail vertical may weigh on IT services firms in near term

Analysts see no recovery in retail segment before end-2014

While a broad-based improvement in several economies has led to most business segments coming out of the woods, the retail sector has emerged as a concern for several large Indian information technology (IT) services companies through the past two quarters.

For three IT services heavyweights — Infosys, Cognizant and Wipro — earnings for the quarter ended June were pulled down by a slump in the retail segment. While these companies said this was due to “client-specific” and “company-specific” issues, experts believe several challenges surrounding the retail sector could continue to weigh on the performance of Indian IT services companies in the near term.

WEAK RETAIL BUSINESS

• Analysts expect weakness in retail vertical till end-2014
• Wipro saw "big issues" in retail in Apr-Jun 2014
• Cognizant saw few retail clients re-looking IT budget, re-prioritising
• Retail business going through transformation
• Retailers struggling retain profit margin
• Several retailers in US & UK undergoing restructuring
• Retail now among top 3 verticals for IT firms

“Retail businesses are going through transformational changes due to the picking up of e-commerce. Now, these companies are struggling to retain their profit margins due to the new-found competition. A few companies have been impacted more than others. These disruptive changes might have impacted the revenue outlook for Indian IT selectively, depending on client-exposure,” said Shashi Bhusan, senior research analyst (institutional equities) at brokerage firm Prabhudas Lilladher.

“For large Indian IT firms, retail has been the second- or third-largest vertical after BFSI (banking, financial services and insurance) and telecom. Any change in the landscape of the retail vertical will have an impact on the prospective earnings of large Indian IT companies,” Bhusan added.

The retail sector has been at the fore of adopting new technologies such as social media, analytics and mobility, making it a significant revenue-generator for technology firms.

Experts said the stress on the retail vertical could be due to the fact that several clients in the retail space in the US and the UK were faced with internal challenges. For instance, Marks & Spencer, one of the UK’s largest retailers, has been restructuring its business through the past few years. As part of this, the London-based company has shut a few non-profitable stores and cut jobs. According to several UK media reports, Tesco, another large retailer, has embarked upon a major restructuring of its business, replacing the current store format-based divisions with regional divisions.

“The performance of retailers in the US and the UK hasn’t been very good through the past few quarters,” said Ankita Somani, analyst at MSFL Research. “Even as the commentary about most sectors has improved, there aren’t many positives on the retail sector. I think the sentiment in this sector might continue to be pessimistic for another quarter; some revival might be seen in October-December.”

Last week, Nasdaq-listed Cognizant (which follows the offshore business model of Indian IT services companies) said it had witnessed weakness in business during the April-June quarter, primarily due to a “handful of accounts” in the retail space in Europe performing poorly. “It is very client-specific...we do have situations in which a handful of accounts are going through a re-look at budgets and re-prioritising,” said Rajeev Mehta, chief executive (IT services). He had, however, added on a broad level, the sector looked “quite optimistic” and Europe offered several opportunities in this segment.

For two quarters, India’s third-largest IT services company, Wipro, has continued to record weakness in the retail vertical. At the end of the quarter ended June this year, the company had said it had “big issues” in this segment, primarily because existing orders had been completed and new orders were yet to come in. T K Kurian, the city-based company’s chief executive, had said he expected this weakness to continue for another quarter or two.

“Our retail business has declined substantially. It is not client-specific; we are seeing this across customers in the US,” Kurian had said at the end of the March quarter.

“The reason is we are on the ‘change’ side of the business, not the ‘run’ side. We do new projects and new development, where clients have cut business. But in the retail sector, you can’t stay away from new development for long. The demand will return,” he had added.