Positive signals

IT companies have done better than expected

The third quarter (October-December 2022) was expected to be grim for the IT sector. Guidance had been cautious, citing margin pressure, seasonal weaknesses, order delays in the recession-hit European Union, and increasing caution among US-based clients. The initial results from some of the bigger IT services firms suggest that demand was somewhat better than hoped, and some supply-side issues seem to be easing for the industry. Revenues growth beat consensus stock market expectations for TCS, Infosys, and HCLTech. This is a positive signal, given that these companies have an aggregate exposure to all regions, and to a broad spectrum of different market segments and verticals. Moreover, labour attrition has declined, suggesting that the churn is declining. Part of this could be attributed to the cooling off in the start-up space, which has meant a reduction in the demand for coders. This has also eased pressures related to expenses on wages and employees, though these remain above historical levels.
 

However, there are also clear margin pressures. Growth in profit after tax was lower than expectations and operating margins were stagnant or lower except in HCLTech. The net headcount actually declined for TCS, implying that India’s largest IT company is anticipating a moderation of demand. Management guidance from TCS also indicated that deal wins were weaker on a sequential basis, as anticipated in earlier guidance. HCLTech and Infosys had more optimistic projections on this front. Vendor consolidation, cost optimisation, and large IT transformation appear to be the potential growth areas in the near term. The UK is firmly in cost-optimisation mode, which means firms are spending on IT only where there’s clear visibility that such expenditure will result in lower costs. The EU has hit the “pause” button to some extent. But this could be partly seasonal and also dependent on resolution in the Ukraine war. Even in the US, clients are holding back on IT expenditures as the Federal Reserve continues its anti-inflationary policy.
 

The currency situation is also worth noting. Due to the strong dollar, the IT sector has gained in North America. However, the rupee has gained versus the pound and the euro, which means that exports to the UK and EU have not received the benefit of a currency boost. Sector-wise guidance seems to indicate demand weakness in financial, retail and tech, and telecom. Discretionary spending rates in these sectors have dropped. Overall revenue growth was led by strong performance in the life science and health care verticals in terms of sectors. Movement to cloud and digitisation continues, but the pace has decelerated in the UK and Europe. Management guidance seems to indicate that growth will be better than expected with relatively resilient demand, and there is an expectation that Indian IT services firms will benefit from revenue market share gain as vendor consolidation becomes a focus area.
 

The geopolitical situation is still volatile, currency swings are a risk, given the inflation conditions, and supply chains continue to remain disrupted by the Ukraine war and due to lingering Covid effects that could impact China reopening, for example. Hence, the global outlook remains fairly uncertain. A global turnaround at a faster than expected pace could result in a quicker project ramp-up and completion. In the absence of such signals, Indian IT can be expected to continue growing but at a somewhat moderate pace.