Reading the tea leaves: Takeaways from Big IT’s Q2 results

Elevated interest rates and weak consumer sentiment in Western economies have led to a continued slowdown in discretionary spends, leading to delays in decision-making as well as deal conversions.

The writing was on the wall when Tata Consultancy Services (TCS), the country’s biggest IT firm, posted a sequential decline in USD revenues for the first time since the coronavirus pandemic marred June 2020 quarter.

Also Read: Infosys reels under pressure after surprise guidance cut

Management commentaries from Infosys and HCL Tech, too, did not inspire confidence.

“Overall, the demand environment is volatile as spending sentiment across enterprises keeps on changing. The management has alluded that it is difficult to project discretionary spending that will bake into the next budget cycle, and also difficult to comment on clients’ propensity to spend in this environment,” Motilal Oswal said in a note.

The biggest shocker was Infosys slashing its FY24 revenue growth guidance for the second straight quarter to 1-2.5 percent from 1–3.5 percent. It had started 2023 with a revenue growth guidance of 4-7 per cent.

"We continue to believe that Infosys is going through some company-specific issues, exacerbated by weak macros. We, hence, expect Infosys to underperform peers in the near-to-medium term," said Nuvama Institutional Equities.

Strong deal pipelines

Deal wins were robust across the board, giving some respite to investors. TCS logged its second-highest-ever deal total contract value (TCV) of $11.2 billion. This was the third consecutive quarter of deal wins staying above $10 billion, an unprecedented occurrence in India’s $245-billion Indian IT industry.

Infosys, which came out with its earnings on October 12, reported its highest-ever large deal TCV of $7.7 billion, three times its average quarterly TCV run rate, aided by four mega deals.

Same for HCLTech. It posted its highest-ever new deal bookings TCV of  $ 4 billion, including a mega deal of  $ 2.1 billion with US-based Verizon, the company said while announcing its earnings on October 12.

This, even as three companies posted tepid revenue growth in Q2, suggests that clients are going slow on project execution due to macroeconomic uncertainties.

Margin improvement

All three companies exceeded analyst estimates on the margin front, thanks to cost-control measures, rationalising employee pyramid and efficiency improvements.

TCS’ EBIT margin came in at 24.3 percent, a considerable improvement of 110 basis points sequentially. EBIT is shot for earnings before interest and taxes.

“Management mentioned there is scope to further improve utilisation, productivity and reduce sub-contracting costs. Margins are likely to increase in Q3 and Q4, as per the management,” ICICI Securities said.

Infosys improved its EBIT margin by 42 basis points (bps) sequentially to 21.2 percent, led by a decrease in selling and marketing expenses (down 1.6 percent QoQ). The same was the case for HCLTech, which saw its EBIT margin spurt by 150 bps QoQ to 18.5 percent.

One basis point is one-hundredth of a percentage point.

Declining Headcount

A muted hiring environment was expected this quarter as IT companies were conspicuous by their absence across premier engineering institutions in September when the placement season begins.

Infosys, which saw its steepest-ever fall in headcount in a quarter, made it clear that it does not plan to go to campuses for hiring this year at all.

The companies also reported falling attrition rates in Q2, signalling that the post-COVID heydays of abundant tech jobs and eye-popping hikes may be over for software engineers.

In a note on TCS, analysts at foreign brokerage firm Jefferies said its strong headcount decline indicates demand uncertainty.

“TCS' headcount fell by 6.4k QoQ - highest quarterly decline in a decade raises doubts on near-term demand and a 2H recovery. LTM (last twelve months) Attrition fell for the fourth quarter in a row to 14.9 percent, suggesting an easing labour market,” they added.

Also Read: Infosys skips college campuses, HCLTech hiring on track

New Buzzword in Town – Generative AI

It’s not just Nasdaq-listed tech titans who have hitched their wagon to the hottest tech trend — artificial intelligence (AI).

TCS, Infosys and HCL Tech were more than eager to flaunt their AI credentials in the Q2 earning announcements. Managements also fielded a flurry of questions around AI during their post-results press conferences.

“We now have a 100,000-strong pool of Gen-AI Ready consultants and prompt-engineers who are engaged in hundreds of Gen-AI projects for our clients across segments,” TCS Chief Operating Officer and Executive Director N Ganapathy Subramaniam said.

Infosys’ CEO and MD Salil Parekh said the growing adoption of its generative AI offering, Topaz, is helping it deliver consistent value and expand market share.

HCLTech, too, highlighted its deal wins in the emerging areas of generative AI, internet of things and automation.

“TCS has trained 100K employees in Gen AI and is working on several Gen AI use cases with clients, but it is yet to contribute materially to revenue. Management is seeing progressive increase in Gen AI use cases from knowledge discovery and customer support chat boxes to more advanced use cases of AI-led molecule discovery, AI-led advisory in wealth management etc.

“However, due to current challenging macro environment, major investments by clients around Gen AI will be funded by cost savings in other areas of tech spending, believes management,” ICICI Securities pointed out.