Analysts Caution On Indian IT Demand; High Attrition, Margin Woes To Weigh

India’s IT services companies could continue to see higher attrition, margin pressures and demand weakening in the coming quarters, according to analysts.

“India IT companies could continue to report high attrition and margin pressures, limiting pace of QoQ improvement in the coming quarters versus what is built into consensus estimates,” Morgan Stanley said in a report.

This comes after Accenture Plc.—which follows the September-August fiscal—reported its fourth-quarter results on Thursday, guiding for a less-than-expected growth in the ongoing financial year.

Nomura said Accenture’s 8-11% constant currency growth guidance for fiscal 2023, when compared with 26% in fiscal 2022, indicates a demand moderation for IT services, albeit still above pre-pandemic levels of 5-8% for financial years 2017-2020.

While keeping a cautious view on the demand outlook, the brokerage said consensus’ revenue growth estimates for fiscal 2024 may see downward revisions. In addition, cross currency may continue to be a material headwind to the reported growth of Indian IT firms in fiscal 2023, it said.

Morgan Stanley, however, said the revenue growth guidance was ahead of its consensus of 7-10% year-on-year. Highlighting Accenture’s lower strategy and consulting business growth, Morgan Stanley said it expects a “similar” trend play out for the Indian IT sector. The consulting part of the business could see moderation in coming quarters, it said.

Jefferies said Accenture’s 22% revenue growth in the fourth quarter suggests “strong” growth for India IT firms in the second quarter ending September of fiscal 2023.

While bookings went up 31% year-on year in constant currency to $18 billion, a rising focus on cost optimisation, weaker hiring and soft fiscal 2023 revenue growth guidance suggest “some caution is starting to creep in”, Jefferies said in its investor note.

It kept its bearish stance on the sector, citing that Accenture’s growth guidance poses downside risks to its revenue estimates.

• Revenue from consulting up 14% at $8.33 billion

• Revenue from outsourcing up 16% at $7.09 billion

• Earnings per share at $2.6 versus $2.2

• Bookings rose 22% to $18.4 billion

• Free cash flow at $3.61 billion

• The operating cash flow stood at $3.79 billion

• Operating margin stood at 14.7%

Accenture’s attrition rate in the fourth quarter remained unchanged from the previous quarter at 20%, which is one of the “highest levels ever”, said Morgan Stanley in its investor note. The management, it said, expects the tight labour markets and wage inflation to continue.

According to Nomura, the net employee addition for the software exporter remained low at around 12,000 despite a “high and sticky” attrition rate mainly due to supply-side headwinds. “We expect attrition to remain elevated over the next few quarters for Indian IT companies.”

• Operating margin 15.3% to 15.5%.

• Free cash flow pegged at $7.7 billion to $8.2 billion

• Operating cash flow between $8.5 billion to $9.0 billion

• Effective tax rate expected to be between 23% to 25%.

• Fiscal 2023 guidance of 8-11% constant currency growth versus 26% in fiscal 2022 indicates demand moderation. On the EBIT margin front, Accenture has guided for 15.3-15.5% in fiscal 2023, representing 10-30 basis points year-on-year improvement.

• However, guidance of fiscal 2023 is still above pre-Covid levels of 5-8% for financial year 2017-2020.

• Reiterates cautious stance on the demand outlook.

• Consensus’ revenue growth estimates for fiscal 2024 will likely see downward revisions.

• Cross-currency will likely continue to be a material headwind to the reported growth of Indian IT companies in fiscal 2023.

• Higher depreciation of European currencies may negate benefit of the Indian rupee’s depreciation against US dollar to Indian IT companies.

• Attrition remains “high and sticky”. Expects attrition to remain elevated over the next few quarters for Indian IT companies.

• Prefers large-caps over mid-caps.

• Investors are likely to get disappointed on margins in fiscal 2023 and on growth in fiscal 2024.

• Keeps ‘buy’ call for Infosys Ltd. and Tech Mahindra Ltd. (in large caps), in that order, and Persistent Systems Ltd. (in mid caps).

• Maintains ‘reduce’ call for Tata Consultancy Services Ltd. (in large cap) and L&T Infotech Ltd. (in mid caps).

• Maintains ‘overweight’ rating on Infosys Ltd and Tech Mahindra Ltd.

• Expect some pullback in IT stocks in short term given significant underperformance in last three months (vs Sensex) and some optimism around growth for FY23.

• Keeps view on time and/or price correction for stocks until clarity on calendar year 2023 budgets emerges and margin pressures subside.

• Revenue growth of 22% year-on-year in constant currency in the fourth quarter was ahead of its estimates and consensus by 0.7% and 0.2%, respectively.

• The fiscal 2023 revenues growth estimates by the company to be 8%-11% year-on year in local currency as compared with Morgan Stanley estimates of 7-10% year-on-year.

• FY23 revenue growth guidance slightly better-than-expectation which points towards some optimism in growth for India IT companies.

• Margin pressure implies that EPS downgrade cycle will continue.

• For India IT peers, the outsourcing revenue growth becomes a more important proxy than just the overall revenue growth of Accenture.

• India IT companies could continue to report high attrition and margin pressures, limiting pace of QoQ improvement in the coming quarters versus consensus estimates.

• Expects consulting part of the Indian IT businesses to see moderation in coming quarters.

• Accenture’s strong growth in 4QFY22 bodes well for growth of Indian IT firms in 2QFY22.

• The growth implies a strong 21% CAGR over 4QFY20 revenues in constant currency terms.

• The strong rise in outsourcing bookings along with moderation in consulting bookings could be a reflection of worsening macro.

• Healthy order bookings in outsourcing are good at the outset; however, large deals driven by cost take-outs potentially reflect rising caution among clients and do not bode well for smaller IT firms.

• Its fiscal 2023 organic growth guidance of 5.5-8.5% year-on-year in constant currency, is below brokerage's estimates of 14%/8% year-on-year constant currency growth expectation for Indian IT firms for FY23/FY24E, which may pose risk to its FY24 estimates.

• Remains selective on the sector with Infosys Ltd. as its only pick as sector valuations are still at a 10% premium to 10-year average levels.