Issues plaguing the midcap IT sector

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Issues plaguing the midcap IT sector

Speaking to CNBC-TV18, Sandeep Muthangi of IIFL said a severe supply side pressures is playing havoc with the midcap IT companies, who are on the verge of seeing delivery disruptions.

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Excerpts from Bazaar on CNBC-TV18 Watch the full show » RELATED NEWS Vibhav Kapoor suggests sectors to play in a corrective mkt See Sensex at 22000 by year end: Deutsche Bank Why is Bowen Capital bullish on NBFC stocks? ALSO READ See what other experts are saying about markets See what FIIs are saying about the markets See what Udayan Mukherjee is saying about the markets

Q: On the cost front that you spoke about many of the midcap IT companies typically operate in the 18-20% kind of earnings before interest, taxes, depreciation and amortization (EBITDA) margin profile give or take a bit. Do you think that will worsen significantly going forward in the next four-eight quarters?

A: I would be heart pressed to find many midcaps in 18-20% margins. Even if you look at the last quarter, just look at the impact of wage increases. Larger vendors have broadly maintained their margins in 100-200 bps range, whereas the mid tier IT vendors had 500-550 bps of margin falls, lot of mid tier vendors. So, lot of the margin fall has already happen.

What you are seeing is - (1) it's very difficult to recover the margin fall that has already happened. (2) there could be further escalation of cost as you go ahead and try to fulfil your demand. Also look at the wage increase, most of the larger vendors including Infosys and HCL Technologies had more than one round of salary increases. One round of salary increase, which was very broad based, but selectively they had increased salaries during December of last year. Some of the companies had given bonuses, Mphasis had a bonus, TCS had a good variable bonus before the actual salary hikes kicked in.

So, if you include all the net salary hikes that have happened at the larger vendors, they are much ahead of mid tier vendors. So we may even see escalation from that front; we may see bonuses going up and the risk of laterals anywhere there. So, most of the margin fall has already happened, it's very difficult to recover it. Even going forward, we could see some further cost escalation at them.

Q: What are the typical kinds of midcap IT names that you have under coverage where you are recommending a sell or reduce?

A: We cover a broad range of midcaps; we cover MindTree , we cover Hexaware , Infotech, so there is broad range of midcaps, which we cover, diversified niche etc. We are having a reduced recommendation on almost all the midcaps. The only midcap IT company that we have a buy on, which is not a very typical IT services company, is Info Edge .

Q: On Tech Mahindra specifically, did you further lower your recommendation after the exit of the CEO?

A: No, we are not revising our recommendations or earnings on the exit of CEO because these are process based companies. The processes are strong etc, but the challenges with Tech Mahindra remain and it's more of client specific thing. BT, we all know is going through a very challenging phase and it is not unfair to expect Tech Mahindra to grow when BT itself is undergoing severe challenges. So, that is primarily BT related issue with Tech Mahindra.