Poised for growth

Margins will improve for the IT sector

India’s $190-billion information technology (IT) sector is at the leading edge of exports, and also the major creator of high-end, high-skilled jobs. The October-December 2021 (Q3) results and guidance from the “Big Three” —TCS, Infosys, and Wipro —indicate the sector is likely to continue seeing robust demand. The pandemic has boosted demand for IT services, with companies everywhere looking to advance their digital presences, as work-for-home protocols have taken hold. The economic recovery in North America has been an especially strong driver for revenues, with Indian IT dependent on that region for the bulk of its revenues. All three IT majors registered strong revenue growth, and new “deal wins”, indicating more companies have enhanced their IT budgets. The industry’s internal assessment is that the shift to cloud computing services is still in the relatively early stage, with more companies jumping on that particular bandwagon and early adopters attempting to complete the transition. This in itself is likely to ensure demand remains both strong and stable in the next two years.
 

The revenue guidance for Q4 and beyond, from the three managements, was upgraded for TCS and Infosys, and stable for Wipro. Declared Q3 revenues were on the higher side of consensus expectations as well. Growth was spread across most verticals, which means that smaller IT outfits, which focus on specific areas are also likely to do well. Industry watchers were worried about margin pressures, which most IT companies have complained about for a while. This is intimately tied to a high employee churn, since employee-related costs are a key metric in the expenses. Since the pandemic started, the industry has seen both a higher churn and higher compensation (and higher other employee-related expenses) as companies strive to retain skilled employees. Every IT company has been forced to hike compensation at least twice in the previous 12 months to try and stem attrition and retain mid-level employees, which is where the churn is most evident. It was a given, therefore, that the margins would be low on an annualised basis compared to October-December 2020. The margins were also lower on a sequential or quarterly basis, and this too had been predicted by industry watchers. It is a pattern that’s likely to repeat across the industry.

However, the consensus seems to be that the worst of the attrition is over and it also appears that the services industry is confident about pricing power. All three managements seem to agree upon this. New deals have been concluded at higher rates, and even old clients appear agreeable about paying more. Moreover, the dollar is expected to strengthen, given the Fed’s hawkish stance, which will also boost rupee-denominated profits. This leads to the possibility that the margins could expand over the next financial year as attrition stabilises. The industry is also looking to hire more, with all three majors planning to substantially increase their net headcount. This is a good signal. The IT industry is in some ways a proxy play on the US economy. America has made a remarkably fast recovery and should see growth acceleration as the infrastructure renewal mega-plan gains momentum. This is happening even as growth estimates are being cut in China, the EU, and even India. So, the IT industry could be an outlier that helps to prop up the Indian economy even if domestic growth is slowed down by Omicron.