IT Companies Growth Slowing as Expected; Outlook Stable Due to Low Debt Levels

Key IT companies weighted average revenues grew sequentially in 1QFY17 by 1.2%, which is less than half the previous year same quarter and is in line with the growth slowdown expected, says India Ratings and Research (Ind-Ra). Ind-Ra maintains a stable outlook on Indian IT companies, on the back of low debt levels and continues to expect IT company's growth to remain in the range of 8%-9% in FY17. The growth slowdown in FY17 is expected due to lower budget allocations of clients in North America (constitutes 55%-60% of Indian IT companies revenues). Uncertainty on Brexit would also result in clients delaying IT spends and putting budgets on hold.

Ind-Ra notes that historically, the first two quarters of the financial year are the stronger quarters and sets the pace for the full financial year, since client budgets are finalised and fixed on a calendar year basis and flows to Indian IT companies in the first and second quarter of the financial year. The growth rates in the third and fourth quarters are usually lower than the first two quarters.

The margins of IT companies declined by 130bp in 1QFY17, reflecting an almost identical 130bp increase in wages. Ind-Ra expects margins to come under further pressure, with the increasing proportion of fixed cost application development and maintenance contracts and the pass through of savings from automation. Fixed cost application development and maintenance contracts constitute about 50%-60% of the revenue and the proportion is expected to rise further. Also clients continue to push for passing on the benefits of automation to them and the same is also likely to become a pre-requisite for the renewal of some of the contracts at lower rates than earlier.

Ind- Ra believes that the uncertainty arising due to Brexit will lead to clients delaying their IT spends on both 'run the business' and 'change the business' projects in EU and UK, there by impacting the growth from this region. EU constitutes about 1/3 of the total revenues of Indian IT companies and around 60% of it comes from UK. The impact on EBITDA margins however is still not clear. The lack of mobility of skilled manpower in the European region may result in further increase in the subcontracting costs. The depreciation in GBP or EUR against INR, due to Brexit can be another factor which will impact profitability of contracts originating from the European region.

The outlook on Indian IT companies remains stable on the back of low debt and high cash levels. The top four IT companies have a comfortable cash cushion of over 7 times their total debt. Cash balance of the top four stood at INR929bn and debt amounted to INR130bn as of FY16.

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