Will IT growth rates sustain?

Nasscom president Som Mittal has reiterated the IT industry’s projection of a 12-14% growth in revenues in the year till March 2014. After the decent September-quarter results season, there’s little doubt that the industry will meet this target set earlier in the year. Even Infosys Ltd, which has been lagging its peers, nearly achieved double-digit growth in organic revenues last quarter.

The pertinent question is if growth rates will sustain in the next fiscal year. According to a recent report by JP Morgan Research, “Available indicators at this point in time suggest that 2014 will likely be a year of consolidation, with a decent probability of a mild pick-up relative to 2013 (though we may not see a marked growth pick-up in 2014 versus 2013). We see industry growth for FY15 at 13-15%.”

The analysts give two main reasons for this: a) data from Europe suggests demand from the region is likely to pick up; and b) discretionary spend, led by the US region, is looking up and should sustain. Additionally, they say that 2014 is likely to be a better year for large, legacy rebid contracts, and that while this may not reflect in financials immediately, deal wins in this space will be positive for investor sentiment.

The September-quarter results showed that demand in key regions such as North America, and in verticals such as banking and financial services and manufacturing, has improved. Also, services dependent on discretionary spending by customers did well, indicating that customers are gradually loosening their purse strings.

Yet, having said all this, stock returns are not expected to be spectacular, especially given where valuations are already. Tata Consultancy Services Ltd trades at 21 times estimated earnings for the current fiscal year. While reported earnings growth has been much higher lately, that’s largely because of the sharp depreciation in the rupee this year. Adjusted for currency benefits, growth rates are much lower.

Besides, as pointed out earlier, growth rates are not expected to pick up substantially next year—based on JP Morgan’s estimates, they are expected to increase by only by one percentage point. In the near term, there may be a blip owing to furloughs taken by US companies. In the past, this has been a phenomenon largely restricted to the manufacturing sector. But according to the head of a large IT services company, it appears that companies in other industries are likely to follow suit this year to save on costs.