The Indian IT sector, which had a sombre start to the FY24 earnings season, is expected to post muted numbers in the second quarter as well as the demand environment remains subdued amid recessionary headwinds in the West, analysts said.
However, select mid-tier IT firms are likely to maintain their outperformance in comparison to the tier-I players, they added.
TCS will kick off the Q2 results season on October 11, followed by Infosys and HCL Tech on October 12.
“The growth of the IT services industry is expected to remain weak in 2QFY24, as macroeconomic uncertainty continues to weigh on discretionary spending,” domestic brokerage firm Motilal Oswal said.
“While the industry has witnessed an uptick in order inflow over the past two months with a focus on cost efficiency, the slowdown in project-based business is expected to hamper overall industry growth, even though Q2 is traditionally a robust season for the sector,” it added.
The brokerage firm further said its IT services coverage universe should report a median revenue growth of 1.5 percent QoQ/5.7 percent YoY in Q2 -- among the slowest observed over the last decade.
Global Macros
The IT industry is currently reeling from the impact of an uncertain demand environment due to economic growth concerns in the US and Europe – its bread-and-butter market.
However, there is an anticipation that this subdued demand environment will begin to improve in the subsequent quarters.
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Economists at BNP Paribas continue to expect the US to slide into recession, albeit a mild one, with inflation to normalise gradually.
Lateral data points they track show signs of bottoming out, with US IIP growth recovering in August after turning negative in July and US PMI, both manufacturing and non-manufacturing, starting to recover in recent months.
That said, the situation will still take some time to settle down, which means Q2 may not deliver the positive news investors are hoping for.
“Both global and Indian IT companies (have expressed) confidence in a recovery during the second half of the year. Nevertheless, we anticipate that this recovery will be gradual at best,” analysts at B&K Securities noted.
The majority of IT companies have reported that the decision-making process is experiencing delays due to increased vigilance caused by changes in the macroeconomic environment. These delays are particularly evident in short-term transformation deals, they added.
Recent results from Accenture also highlighted the challenges facing domestic IT service players.
The Dublin-based IT company, which has a large percentage of its workforce in India, reported a narrowing of revenue growth for the sixth consecutive quarter to 4 percent.
Accenture estimated revenue growth of 2 to 5 percent in FY24, and CEO Julie Sweet said the company is not assuming an improvement in the discretionary spending environment or the macro.
According to a note by Kotak Institutional Equities, this is the “second-lowest among the beginning of year guidance in the past 16 years.”
Art of the Deal
A major source of optimism for IT companies, at least over the medium term, is a strong deal pipeline.
“Deal bookings in the sector have been robust, with several mega deals centering around cost optimization and consolidation,” HDFC Securities said in a note.
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Key multi-year, multi-million orders in recent times include JLR, Georgia DOL deals by TCS, Liberty Global, Danske deals by Infosys, and Verizon, Siemens, and ANZ deals by HCL Tech.
“AI spending and adoption are expected to accelerate and supplement growth, even as cloud migration and application modernization will be large medium-term spend imperatives,” HDFC Securities added.
While most IT services firms saw a further moderation in y-o-y revenue growth in the June quarter, deal wins accelerated.
“Since then, the large/mega deal win momentum has quickened, giving us confidence in strong growth for FY25,” BNP Paribas said.
Analysts at Motilal Oswal echoed the views.
“Deal TCVs (total contract value) should look attractive with recent mega deal wins for selective names. We expect collective deal TCV (Tier1 + Tier 2) growth to stay inline or improve sequentially vs Q1. Q1 reported 1 percent QoQ decline in deal TCV. However, with elongated ramp-up, these deals will have limited contribution in the second quarter,” they added.
Motilal Oswal expects revenue growth of tier-I companies to be in the range of (-)1.2 percent to 3.6 percent QoQ (on a constant currency basis). Revenues of tier-II players are expected to grow to the tune of 0.4 to 3.2 percent QoQ, it added.
Key Monitorables
According to global brokerage firm Jefferies, the focus would be on commentary around the demand environment and any signs of improvement or expectations of recovery in 2HFY24.
Also, commentary around generative AI would be of interest.
For Infosys, the focus would be on leadership churn and its margin program, while for TechM, it would be on strategy under the new CEO and margin recovery, it said.
“For Coforge, focus would be on execution post the Barings stake sale. We do not expect any change to FY24 guidance for any firm, except for HCLTech, which could hint towards achieving the lower end of margin guidance,” it added.
It also expects margins to be flattish on an aggregate basis for its coverage universe, with tepid growth offering limited scope for margin expansion.
“We expect 20-40 bps margin expansion for TCS, Infosys and HCLTech, driven by higher utilization and operational efficiencies. We expect a sharp margin contraction of 170bps for LTIMindtree due to wage hikes and 80 bps for Tech Mahindra due to provision on receivables and revenue decline. We expect Wipro's margins to contract by 30 bps due to revenue decline,” it added.
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