Accenture Plc ended its fiscal year on a strong note, with revenue growing by 11% in constant currency in the fourth quarter. In the 12-month period till August 2018, revenue grew 10.5%, far higher than the 5-8% growth it had guided for at the beginning of the year. The company’s results indicate demand for IT services is picking up. But this is old hat as far as Indian investors are concerned. NSE’s Nifty IT index has risen over 38% this year, and among the myriad justifications for the rise has been the assumption that a turnaround in global IT spending will result in better times for the Indian IT sector.
It’s another matter that growth hasn’t picked up for the majority of large Indian IT firms. Among India’s top six software exporters, only Tata Consultancy Services Ltd (TCS) is expected to report an increase in growth rates in the fiscal year till March 2019. And even in its case, incremental growth is being driven by some large projects in the insurance vertical. Expecting growth to sustain at double-digit levels in FY20 looks like a tall order even for TCS.
Why is Accenture doing better than most of its competitors from India? Analysts at Kotak Institutional Equities said in a note to clients, “We believe a couple of factors are aiding Accenture’s growth rates—(1) participation in the full lifecycle of clients’ digital journey through its consulting, design and full spectrum of digital competencies that is strong across verticals and geographies; and (2) a portfolio that is nicely balanced between legacy and new, reducing the friction on growth."
Indian IT firms have generally fallen short on both counts, with investments in digital capabilities lagging behind, besides having a large exposure to traditional services, where spend has continued to fall.
Of course, one can argue that they have done well despite the drag from the higher proportion of traditional services in their portfolio. But the fact remains that growth hasn’t picked for the majority of Indian companies, while valuations have risen significantly. As such, it doesn’t make sense for investors to get excited just because Accenture is reporting better-than-expected growth rates.
Besides, there are a couple of notes of caution in Accenture’s results announcement. First, growth in the financial services vertical fell to a multi-quarter low of 3% on a year-on-year basis in constant currency. Since Indian IT derives a large share of its revenues from this vertical, investors may need to tread with some caution.
More importantly, Accenture’s guidance for the year till August 2019 suggests growth might slow down. It has guided for growth of 5-8% in constant currency, lower than the 10.5% growth it reported last year. At the mid-point of its guidance range and after adjusting for contributions from mergers and acquisitions, the company is guiding for growth of roughly 5%, as compared to 8% organic growth last year.
Accenture said on a call with analysts that the guidance reflects macroeconomic uncertainties such as Brexit, trade wars and high commodity prices, which can potentially impact demand from clients.
Valuations of Indian IT stocks suggest there is no need to worry about any of this. On an average, IT stocks trade at about 20 times FY19 earnings, and TCS, the leader of the pack, trades at as much as 26 times earnings. True, some of this is on account of the sharp depreciation in the rupee, but it must be noted that gains for IT companies on this count will only be temporary (bit.ly/2M2SPmz).
As an analyst at a multinational brokerage firm points out, the main reason Indian IT stocks are flying high this year is that they are seen as a safe haven at a time when most other shares are falling. While valuations may be high relative to earnings growth, they are less expensive than many other sectors. Even so, given the fact that investors are banking on a material increase in growth rates, there is ample room for disappointment.