The recent banking crisis in the United States is expected to have an impact on the earnings of Indian information technology (IT) services companies in Q4FY23, with analysts pointing to weak sequential revenue growth. Despite prompt intervention by central banks, which appears to have contained the banking crisis for now, the risk of further disruption remains.
The banking crisis in the US played out from the beginning of March this year, when Silicon Valley Bank (SVB), a lender to tech companies, especially start-ups, faced a run on its deposits and ultimately went under. Another US bank, Signature Bank, followed. A third bank, First Republic Bank, was given support. The biggest casualty was Switzerland’s Credit Suisse, which was taken over by UBS through a government-backed action.
Given Indian IT companies' heavy dependence on Banking, Financial Services, and Insurance (BFSI) sector for their revenue, IT related spending cuts and extended decision-making cycles implemented by clients in this segment are likely to impact the companies' top line.
Weak revenue growth
According to analysts at JM Financial, the immediate impact on IT services seems to be more on the elongated decision cycles than actual spending cuts. "Recent ructions in the global banking space mean new project starts and the usual year-end flurry of deal closures might have been pushed out," they note. It believes that firms may land in the lower half of their guided Q4 band and assume their large-cap coverage universe (top-6) to report negative 0.6 percent to 1.2 percent constant currency (CC) quarter-on-quarter (QoQ) revenue growth.
ICICI Securities also warns that while deal pipelines have not shrunk, conversion to new deal wins is taking longer. In some cases, the conversion of order book to revenues in terms of deal ramp-ups is also taking longer than usual.
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“This, in our view, implies right shifting/postponement of demand to H2FY24E or even FY25E as the digitalisation agenda of clients remains largely intact, but their near-term focus has shifted to cost optimisation and increasing efficiency,” it said, and expects revenue growth in the range of negative 1.9 percent (HCLT) to 0.5 percent (LTIM) in CC terms.
Higher BFSI exposure companies such as TCS, Infosys, Wipro, LTIMindtree, Coforge and Mphasis will need to be closely monitored to understand the impact of the banking crisis on their revenues, going forward, according to Asian Market Securities (Amsec). The adverse impact of IT-related spending cuts should primarily be on discretionary spends, it says, and believes that cost optimisation and vendor consolidation-related spends should remain the prime focus over the next three to four quarters. It projects large companies to report revenue growth in the narrow range of negative 1.6 percent to 1.1 percent QoQ in CC terms, and mid-tier companies to have a wider growth band in the range of negative 5 percent to 5 percent QoQ in CC.
Brokerage firm Motilal Oswal predicts its IT services coverage universe to deliver a median revenue growth of 0.8 percent QoQ and 9.2 percent YoY in CC terms in Q4FY23. Apart from BFSI, Hi-Tech, Manufacturing and Retail may also report muted growth in Q4, it added.
Margin relief
While a weak macro is expected to impact Q4FY23 revenue growth, margins can see some improvement on the back of easing supply pressure, cooling off attrition, and improvements in utilisation, according to the brokerage.
“Tier-I companies should post flat margins, with HCLT (down 150 bpd QoQ on P&P (products and platforms) seasonality) and LTIM (up 180 bps QoQ due to recovery from Q3 low base) being the exceptions. The Tier-II pack will post a wider range of flat to 200 bps QoQ, led by Coforge/Zent with margin improvement of 200 bps/120 bps QoQ,” it said.
JM Financial sees slower growth and falling attrition to limit the efficacy of traditional margin levers and projects a muted margin performance ((80)-20 bps QoQ) for the top 5 players.
“TCS is likely to miss its FY23 exit margin target of 25% while TechM’s margin recovery will likely get pushed out further. LTIMindtree’s Q4 margins, +150 bps, will benefit from lack of one-off merger-related cost, but will still be significantly below normalised levels. Coforge should report the highest margin expansion in our coverage universe (+170 bps; adjusted earnings before interest, taxes, depreciation and amortisation (EBITDA)) as it pulls up operating levers to achieve its FY23 margin guidance,” it said.
Amsec, on the other hand, expects margins to benefit from easing of supply side pressure and improved utilisation rates. They believe that the difference between margins of mid-tier and large-tier companies will now blur as favourable supply side dynamics will have an almost equal positive flow-through across companies.
Tier-1 vs Tier-2
Cost take-out and vendor consolidation deals are witnessing increase where we believe Tier-1 companies are better positioned to gain market share versus Tier-II companies, it added. The stock broking firm prefers Infosys, HCL Tech and Tech Mahindra in large-cap players.
“We expect Infosys to continue to deliver top robust revenue growth, amid strong deal wins and market share gains, the difference in growth vs TCS narrowing though. At the current valuations of 16xFY25E, we believe HCL Tech is attractively priced. TechM is also trading at attractive valuations of 13.6xFY25E EPS, with expectations of upside risks to FY25E numbers with the new CEO bringing in some positive changes.” In Tier-2, it prefers Cyient, Firstsource and Birlasoft due to their high earnings growth trajectory and comfort on valuations.
Motilal Oswal also prefers Tier-I players over Tier-II counterparts, given the former’s attractive valuations, increased traction in vendor consolidation and diversified client portfolios.
Among Tier-I players, it prefers HCL Tech, and Infosys along with TCS. “TCS remains best positioned to benefit from long-term structural tailwinds in tech services and should see a relative pick-up in growth, aided by clients’ focus on cost optimisation and efficiencies. HCLT is one of the key beneficiaries of Cloud adoption at scale, given its expertise in IMS. We expect Infosys to deliver a strong growth, backed by strong deal wins.” In Tier-2, the brokerage leans towards Cyient and Zensar Technologies.
Brokerage firm ICICI Securities has a ‘buy’ rating on TCS, Infosys and LTIM in large-cap, and Mphasis amongst mid-cap players.
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