The note also that the banking and financial services vertical, a critical segment for the IT industry, is facing its own set of challenges
Growth challenges apart, the industry faces headwinds on the margins front
What goes up must come down. India’s information technology (IT) exports are estimated to have risen 9.2% in FY19, faster than the 7.8% growth in the preceding fiscal, according to industry lobby group Nasscom. With major IT companies set to report FY19 results and provide an outlook for the new fiscal, a moot question is if growth rates will scale down.
After all, apart from the high base effect for some companies such as Tata Consultancy Services Ltd, the industry needs to contend with a global slowdown. This double whammy has already hit growth at Accenture Plc, which reported results for the quarter ended February late last month. The company’s financial year starts in September and ends in August.
In the quarter ended August 2018, Accenture had reported revenue growth of 11% in local currency terms. But this year, growth slowed to 9.5% and 9% in the first and second quarters, respectively. Based on its guidance for the rest of the year, growth is estimated at 8.5% and 7% in the third and fourth quarters, respectively.
“Accenture indicated that macro uncertainties remain and budgets for next year will grow but less than last year," analysts at Nomura Financial Advisory and Securities (India) Pvt. Ltd said in a 29 March note to clients. The fact that Accenture’s growth is dropping even in the March-August period, which coincides with a seasonally strong period for the sector, is a negative, the broker added.
But such worries are missing from the Street’s estimates of FY20 growth as well as commentary by top IT companies. Both seem quite sanguine. The general belief is that growth in FY20 will be more or less similar to that in FY19, on the back of large order wins in the past year. “Benefit from strong deal flow and increasing digital deal sizes will be offset to some extent with slower spending growth in budgets in FY20. We expect broadly similar industry growth in FY20," analysts at Kotak Institutional Equities said in a 29 March note to clients.
The note also that the banking and financial services vertical, a critical segment for the IT industry, is facing its own set of challenges. The segment’s contribution to Accenture’s revenue has fallen sharply, with growth slowing to just 2% in the February 2019 quarter from 7% in the year-ago period. “Any replication of weak BFSI (banking, financial services and insurance)/Europe trends at tier-1 IT could be a risk to Street growth expectations," Nomura’s analysts said.
Apart from the uncertain macro conditions, Accenture’s growth has been hit because of a high base in the year-ago period. Growth of 10-11% was among the highest in recent years, as the chart shows. Likewise, for Indian companies such as Tata Consultancy Services Ltd, growth picked up materially in FY19 and represents a relatively high base as well. But for some such as Infosys Ltd, which is in the middle of a recovery, growth may well turn out to be a tad higher this fiscal.
Growth challenges apart, the industry faces headwinds on the margins front. The rupee has appreciated materially in recent months, which in itself is a large setback as far as profitability is concerned. Besides, thanks to increasing restrictions on visas in the US, the cost of delivering on-site services has increased. “Profitability will face the test of increasing cost on-site," said Kotak’s analysts.
Despite all of these challenges, most IT stocks are now trading at a 25-30% premium to their five-year median valuation multiples, according to JM Financial Institutional Securities Ltd. If growth rates do end up slowing down in FY20, so will these lofty valuations. After all, what goes up must come down.