Amid risks of a slowdown, these IT companies are best placed to survive the storm
- Slowdown concerns and cost-reduction mandates of clients figured in the commentary of Indian IT companies in Q2.
- While India’s top IT companies have shown an improvement in operating margins, analysts suggest two companies are the best placed to survive a slowdown.
- Hiring slowdown, attrition rates and deal pipelines will be the key metrics to watch out for, according to analysts.
AdvertisementThe rate hike cycle unleashed by the central banks across the world has exacerbated the risks of a global recession. This has been a cause of concern for most India’s IT services majors too as they derive most of their business from North America and Europe. Analysts have red-flagged a potential slowdown in their revenues for a while now, even as they battle rising wage costs back home.
Even though many Indian IT companies reported an improvement in operating margins during the September quarter, management commentary also focused on slowdown concerns. According to a report by Kotak Institutional Equities, two companies are best placed to navigate the risk of a slowdown in the US and Europe – the biggest markets of Indian IT majors.
“Infosys will lead growth and gain share even in a slowdown given improved cost take-out capabilities. HCL Tech has delivered robust growth trends in the services business and improved margins,” the report said.
For context, Infosys reported $2.7 billion worth large deal wins in Q2 – its best performance in the past seven quarters. On the other hand, HCL Tech bagged a mega deal worth $625 million.
Both Infosys and HCL Tech also reported stronger than expected operating margins during the quarter, making them the top performers amongst the top four IT companies.
“Despite higher probability of recession in key European countries and an energy crisis, revenue growth in Europe on a constant currency basis continues to be strong,” the report said about the IT sector’s Q2 performance.
Operating margins came under pressure in Q1 due to wage hikes, higher subcontracting expenses and cost of backfilling attrition. In the second quarter, it improved in the range of 15-150 basis points for Tier 1 companies.
“Healthy margin expansion from bottoms of Q1 FY23 will help assuage investor concerns,” the report said, while noting that further room to improve margins is available, and that it will happen over the next few quarters.
Slowdown baked in stock prices – recession, not quite
The broader Nifty IT index has seen a correction of 25.6% in 2022 so far. Except Wipro, top IT companies like TCS, Infosys, and HCL Tech have managed to perform better than the Nifty IT index in this period.
Source: NSE, as on November 1, 2022, 1:30 p.m.
“The second half of FY23 will be impacted by furloughs and seasonal weakness unlike the past couple of years. Stocks have baked in a slowdown, though not a recessionary environment,” the report stated.
“Our view is we are ready in this macro-environment for all types of client work. Whether it focuses on digital and growth, or costs,” said Salil Parekh, CEO and MD of Infosys during the September quarter results, while noting that there are indeed demand concerns in the otherwise resilient telecom sector as well.
Despite these concerns, Parekh sounded cautiously optimistic, with Infosys revising its revenue guidance to 15-16% for FY23, up from 13-15% given at the beginning of this financial year.
HCL Tech, too, managed to deliver stronger than expected results thanks to higher realizations. This, along with the deal wins in the first half of FY23 gave the company the confidence to raise its revenue guidance for FY23 by 50-150 basis points to 13.5-14.5% in constant currency terms.
The report underlines that mega deal activity is muted, with only HCL Tech reporting a single mega deal of $625 million.
“We expect significant large cost take-out deals to fructify in H2 FY23 and FY24. Such deals can cushion the impact of slowdown in global IT spending in FY24,” the report said.
Key metrics to watch out for – hiring slowdown, attrition rate and deal pipeline
Hiring slowdown, deal pipeline and attrition rate are amongst the key metrics to watch out for, according to the report.
Overall, IT majors have cut down hiring by 57% in Q2, with Wipro reporting the most significant cut at 95%, followed by industry leader TCS at 58%.
Attrition rates, too, have remained elevated, with Infosys reporting the worst rates at 27.1%, followed by HCL Tech at 23.8%.
The report also notes that while the deal pipeline remains robust for all companies, deal closures have been impacted in some cases due to delays in decision-making.
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