Indian IT feels the heat of global uncertainty but keeps growth hopes alive

Global headwinds and the resultant weakness in financial services, a large business vertical, weighed on the growth rates of IT firms in June quarter. However, order wins and deal pipelines remain strong to keep growth hopes alive.

Except Infosys Ltd and HCL Technologies Ltd, revenue growth at most front-line IT firms lagged Street estimates. Growth at Tata Consultancy Services Ltd (TCS), the largest company, moderated from the March quarter. Wipro Ltd and Tech Mahindra Ltd reported lacklustre performance.

The slowdown is more pronounced at second-rung firms. High client concentration and slowdown in revenues adversely impacted the profitability of these firms compared to their larger peers. “Mid-tier companies witnessed slowdown in revenue growth on year-on-year comparison to low teens from high teens earlier. Slowdown in growth from large clients and a few client-specific challenges contributed to weak results,” analysts at Kotak Institutional Equities said in a note. “Mid-tier companies have a strong leverage to growth; slowdown in the same has resulted in margin contraction across all companies.”

Profitability softened at large companies as well, with HCL Tech suffering a significant hit. Talent crunch, high subcontracting, deal transition and visa costs impacted profitability. Without the support of currency, profitability can remain under pressure for FY20, said the Kotak analysts.

Even so, as one analyst at a domestic broking firm pointed out some time back, relative to other sectors IT companies’ earnings have been less volatile.

Further order bookings and pipeline across the firms remain strong, providing good visibility. “Total contract value (TCV) of deal wins has been strong across all companies, reflecting a demand environment that is still reasonably good,” analysts at Kotak said. “We appreciate that TCV may not be a reliable indicator for growth due to lack of clarity on renewals of existing business. On the other hand, it is a good indicator for momentum in wins, something that has been comforting up to now.”

Tracking the strong deal momentum, Infosys raised its lower end of the revenue growth guidance for FY20 by one percentage point. HCL Tech is confident of meeting its revenue growth guidance for the full year. TCS, despite pinning growth momentum hopes on the second quarter, is confident about prospects and is stepping-up hiring. Similarly, Tech Mahindra reported strong deal wins for the June quarter.

In comparison, Wipro announced tepid sequential revenue growth guidance of 0-2%. Similarly, company-specific troubles mean growth at Cognizant Technology Solutions Corp. is expected to remain subdued in the near term. The variation in performance and growth profiles explain the valuation gap between Wipro, Tech Mahindra and others. But valuations of other front-line companies at one-year forward earnings estimates are not cheap either.