Q1 IT Preview: Deal Wins To Sustain Growth, Supply Pressures To Drag Margins

India’s largest information technology companies are expected to report revenue growth, aided by deal wins, in the quarter ended June even as cross-currency movement, wage hikes and supply pressures continue to weigh.

The aggregate revenue of top five IT companies in terms of market capitalisation—Tata Consultancy Services Ltd., Infosys Ltd., Wipro Ltd., HCL Technologies Ltd. and Tech Mahindra Ltd.—is expected to rise nearly 3.98% sequentially, according to analysts’ estimates compiled by Bloomberg. But none is expected to report a rise in net profit as the combined net profit is seen declining nearly 2.5%.

Estimates peg the highest constant currency revenue growth for Infosys. However, its net profit is expected to fall 0.54%.

Analysts expect Tech Mahindra’s net profit to fall 16.67%, the steepest among the top five companies.

Meanwhile, U.S. dollar revenue is expected to be lower in this quarter due to cross-currency headwinds.

“We estimate higher negative impact of cross-currency headwinds of 100-200bps on USD revenue growth in Q1 due to sharp depreciation of EUR, GBP and AUD (-5.1%, -6.3%, -1.28%) against USD,” according to Prabhudas Lilladher.

ICICI Securities expects a sequential decline of 50-200 basis points in margins for tier-1 IT services and 20-250 basis-point decline for tier-2 IT services companies.

“EBIT margin is impacted by headwinds from wage revisions, high onsite wage inflation, higher retention costs as attrition is still at elevated levels, visa costs, higher travel costs and drop in utilisation due to aggressive fresher hiring in last two quarters,” it said in a note.

It pegged the highest sequential decline of 190 basis points in margins among top five companies for Tech Mahindra.

The average of analysts’ estimates compiled by Bloomberg pegged margins for Infosys and TCS at 21.05% and 23.66%, respectively.

ICICI Securities said the first and the second quarter of fiscal 2023 will be the peak for margin pressure and gradually margins will improve from the third quarter onward.

Meanwhile, Prabhudas Lilladher pegged the sequential decline in margins to 100-200 basis points in the quarter from April to June.

However, both brokerages expect these headwinds to be partially offset due to 2.6% quarter-on-quarter depreciation of Indian rupee against the U.S. dollar.

Attrition will remain at elevated levels and supply will continue to stay constrained, leading to elevated replacement costs, according to Motilal Oswal.

A higher intake of freshers will result in lower employee utilisation, which will further constrain profitability, it said.

While the first quarter of fiscal 2023 sustained deal wins, the following quarters may see clients postponing IT spends due to macro pressures.

Amid inflation pressures and slowing economic growth, especially in the U.S. and Europe, revenue momentum is expected to start softening from second half of FY23, and for FY24 on account of clients postponing spends, absence of large deal wins, and softening deal win momentum ahead, ICICI Direct said.

“We believe IT spends are strategically important but not immune to macro pressures.”

Dolat Capital expects smaller deals to dominate the pipeline, and less of “large scale/multi- year engagements”.

Motilal Oswal said its recent discussions with managements indicate continued momentum in spends on technology services, even though it anticipates initial signs of an impact in sectors like retail and manufacturing in the quarter ended June.

IT services companies are expected to keep the guidance unchanged.

Prabhudas Lilladher expects Infosys to maintain its revenue growth guidance of 13-15% year-on-year in constant currency and EBIT margin guidance of 21-23%.

It also expects HCL Technologies to maintain its guidance of 12-14% year-on-year in constant currency and 18-20% EBIT margin band.

"However, cross-currency headwinds are likely to impact USD revenue growth adversely across the IT pack in FY23. Onsite wage inflation and increased travel costs are key risks to margin targets for IT service companies,” it said.

Meanwhile, ICICI Securities expects HCL Technologies will revise its margin guidance lower in the coming quarters. And it expects Wipro to guide for 2.5-4.5% sequential constant-currency growth for the third quarter.

In the quarter ended June, the Nifty IT Index fell nearly 23.33%, led by L&T Technology Services Ltd., L&T Infotech Ltd., Tech Mahindra, Mindtree Ltd., Mphasis Ltd. and Wipro. The Nifty 50 lost 9.65% during the period.