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Companies in the information technology (IT) sector kickstarted the June quarter earnings season amid the euphoria surrounding the Zomato IPO. The initial results reveal an encouraging picture, as Tata Consultancy Services (TCS), Infosys and Mindtree indicated healthy demand and reported decent order wins. Wipro and Larsen & Toubro Infotech are scheduled to release their earnings later in the day.
Infosys and Mindtree reported impressive growth. But both of them and even TCS reported a sizeable reduction in profit margins sequentially. For Infosys, the profit margin erosion was higher than even the Street's expectation. The company raised its revenue growth forecast for the current fiscal, but left its profit margin range unchanged, resulting in only modest changes to analysts' earnings estimates.
If business is growing, why are margins under pressure? The answer lies in salary hikes, deal transition expenses, rise in subcontractor costs, return of travel and discretionary expenditure generating cost headwinds. Theoretically, such situations should also trigger price hikes to pass higher costs to customers. However, Infosys and TCS do not see broad price revisions taking place immediately. But they see scope for differential pricing, the benefits of which may accrue gradually.
The commentary on pricing is at variance with the talent shortages IT companies are facing right now. In fact, the recent quarterly update by Information Services Group (ISG), a research and advisory firm that tracks the commercial outsourcing contracts, indicates slow revision in prices. “Rate cards have not increased significantly in demand skills,” Kotak Institutional Equities said in a note, after attending the ISG call.
Even then, companies see this as a good problem to solve. They believe that they are better-off capturing demand and working on their cost structure. Infosys, for instance, plans to hire 35,000 college graduates that will help it improve the employee pyramid and derive cost efficiencies. TCS plans to add 40,000 freshers. Assigning younger and lower-paid employees to projects is one way of driving up margins.
“What has changed slightly has been of course the demand which has picked up and like I always say it is always better that demand chases supply rather than supply chasing demand because in the long run it is much better to fulfil demand as it comes; we can continue to work on the cost optimisation levers,” Nilanjan Roy, chief financial officer, Infosys, said in the earnings call.
And the IT sector is not alone in absorbing higher costs instead of raising prices. The sharp rise in raw material costs has caught several manufacturing industries off-guard. For example, companies in the automobile and power sectors. But all are not expected to be uniformly hit as one of our pieces on NTPC explains today, with its pricing structure coming in handy to tackle a sharp spike in coal prices.Do check out these investing insights from our research team:
Infosys reaps strong demand gains, handles supply challenges smartly
Emmbi Industries: Growth outlook bullish
Tata Metaliks: Preferred stock to play the water infrastructure theme
What else are we reading today?
The Green Pivot | Carbon pricing needs cautious consideration
Real Estate: COVID-19 has dealt a big blow to affordable housing
Here's why global LNG prices are likely to remain high
Transatlantic inflation surge fuels economists’ fears of overheating (Republished from the FT)
Picks from our Technical Analysts: Jubilant FoodWorks, L&T, L&T Finance Holdings and ITC
(These are published every trading day before markets open and can be read on the app)
R Sree Ram