Does EPAM Systems’ guidance cut signal tough road ahead for Indian IT?

Analysts do expect a spillover effect on Indian IT.

US Information Technology (IT) services company EPAM Systems has cut its growth outlook for the second quarter as well as the full year, potentially signaling storm clouds ahead for the Indian IT industry too.

The news is one more jolt for an industry that has already been hit by weakening demand amid concerns over a recession in the US and Europe following the Russia-Ukraine war.

Analysts do expect a spillover effect on Indian IT. All eyes will now be on Accenture, which will report its earnings for the quarter later this month. Nifty IT was the biggest sectoral loser of June 6, falling over 2 percent.

EPAM Chief Executive Officer Arkadiy Dobkin said in a statement that since the company’s earnings call a month ago, clients had become even more cautious about spending, particularly in the ‘build’ segment of the IT services market.

Build spending is largely discretionary in nature, and 85 percent of EPAM’s revenue comes from the segment.

“After careful assessment of changes in our May and June forecast data, we have come to understand that pipeline conversions are occurring at slower rates than previously assumed and we are also seeing some reduction in the total pipeline,” Dobkin said.

EPAM competes with companies such as Happiest Minds and Persistent Systems in India.

For the full year, EPAM expects a revenue decline of 2 percent in constant currency terms, and has so far slashed its revenue growth expectations by roughly 13 percent over two consecutive updates.

In a note, Kotak Institutional Equities said that the slowdown in discretionary spending would have implications on Indian IT, and expects the quarter ending June 30 to be a weak one.

EPAM expects a recovery in discretionary spending to take two to four quarters, or in the next calendar year.

Kotak said that there were two components to the projected lower revenue: a broad-based slowdown in client spending on discretionary activity with a Quarter-on-Quarter revenue decline expected across industry verticals and geographies, and a more EPAM-specific impact where it is unable to derive higher pricing in a price-sensitive market.

Kotak maintained that delays in decision-making and pullback in discretionary spending have an impact on Indian IT, which it expects to post weaker revenue in the first quarter of FY24 vs. the last quarter of FY23.

“We believe that the demand environment is especially weak in the financial services and technology segments. A prolonged recovery in clients’ willingness to spend would imply downside risks to FY2024 revenue growth estimates,” it said.

Kotak said the impact on EPAM has been made worse due to the its exposure to discretionary spending and other factors specific to the company.

“Indian IT has a more balanced portfolio between discretionary and maintenance spending. Further, Indian IT will benefit from cost take-out programs and mega deals. However, these positives are outweighed by the broader caution in spending, especially in the impacted verticals,” it added.

Ray Wang, CEO of Constellation Research, told Moneycontrol that among the Indian IT firms, he saw mid-size firms doing better than larger firms “mostly because of their specialization in industries and their ability to become more nimble.”

Negative surprises in the offing?

Sanjeev Hota, Head of Research at Sharekhan by BNP Paribas, said Indian IT had recovered some ground in the past month due to positive global cues, but things may be shakier going forward, noting that Accenture reports its numbers on June 22.

“If there is any negative surprise coming from the Accenture numbers, there could be possibility of further underperformance from the Indian IT pack,” Hota told Moneycontrol.

“The thesis of Indian IT is that the demand could improve going into FY25. For Fy24, modest growth is anyway expected. Anything that is going to negatively come out from the Accenture numbers or any other global IT major could put pressure on the entire IT pack because they have already played out the momentum in the last month,” he says.

Pareekh Jain, CEO of information provider EIIR Trend, said that given the area EPAM works in, it will have limited impact on Indian IT firms. He added that large-cap companies had minimal exposure to the kind of clients that EPAM has.

On midcap IT firms such as Persistent and Happiest Minds, Jain said: “Even here, bigger customers are impacted due to which global companies like EPAM have been impacted.”

Persistent and Happiest Minds work with smaller scale clients due to which the impact on them may be less, he added.

Most largecap firms in Indian IT have provided a revenue growth outlook in the mid-to-high single digits; midcaps have maintained double-digit growth as their target.

Jain said that if Accenture also reports lower-than-expected growth, then one can expect the guidance of Indian companies to be revised down. He added that a lot of impact has already been baked into the modest growth outlook numbers that have been given, but any negative surprises will impact Indian IT as well.

Green shoots in H2

Wang of Constellation Research said the outlook is better for the second half of the 2023 calendar year, noting that the US had managed to shrug off a recession despite Federal Reserve rate hikes.

He expects the pickup to be better in the second half as companies are “still entrenched in digitization efforts and now AI (Artificial Intelligence) projects.”

‘The move from products to services, services to experiences, and experiences to outcomes will require a sustained investment,” he added.

Jain of EIIR Trend said the IT sector had been booming for the last two years and valuations had soared high, which are now being dented.

“My analysis is this impacts global firms more than Indian firms because in this scenario also, people will outsource more to India,” he said, adding that while growth may be down for the midcap IT companies, they were still growing in double-digit terms.

Back-ended growth

Hota of Sharekhan maintained that uncertainty remains as the numbers and cues coming out of the US and Europe were still mixed.

“Empirically, H1 is strong for the IT sector and H2 is weaker. In Q4, most companies mentioned that in FY24 there is a possibility of back-ended growth. H2 is going to be the quarters where we can see a recovery happening on a sequential basis, not in the first half,” he said.

The problem pertaining to growth will be more for the top companies where the base is already on the higher side, he said.

Midcap IT firms stand to sustain their growth at least on a relative basis if they are able to win one or two larger contracts due to a low base, he added.

He maintained that while digital transformation was required by every company and those changes were structural, it remained to be seen if discretionary spending will be delayed for a quarter or two or for the full fiscal year.