Markets
IT cos pray for succour in H2
Summary
- The elevated interest scenario has been a drag on the earnings of the IT sector, keeping revenue visibility low
MUMBAI : Information technology (IT) stocks seem to be garnering renewed interest with the Nifty IT index rising 6% so far in November. The better-than-expected October US CPI inflation data has raised hopes that the US Federal Reserve’s rate hiking cycle is nearing its end. If this hope materialises then it should come as a boost especially to the banking, financial services, and insurance (BFSI) sector—a key revenue generator for Indian IT companies.
The elevated interest scenario has been a drag on the earnings of the IT sector, keeping revenue visibility low. After two quarters of a decline, aggregate revenues of the top five IT firms returned to growth in the September quarter (Q2FY24), however, the sequential recovery in constant currency was tepid at 0.3%, said Jefferies India. While midcap IT companies continued to fare better than larger-caps on this parameter in Q2, the revenue growth differential has narrowed.
Further, the sector’s revenue growth outlook for the second half of FY24 is far from inspiring. “Our recent interactions with seven IT services companies highlighted that a pick-up in demand environment remains elusive," said Jefferies in a report dated 17 November. A transition from growth mindset to survival mindset among clients is leading to rising scrutiny of discretionary IT spends, it added.
The Q2 IT results do capture the prevailing client caution. Deal bookings and pipeline were robust but were driven by cost-take out deals. Management commentary suggested that there is increased focus on cost optimization amid challenging global macros. Also, as clients re-prioritize spends, deal closure cycles are taking longer. Slower ramp-ups of large programmes have meant delayed conversions of deals, thus restricting revenue growth. It is hardly surprising that large caps Infosys Ltd and HCL Technologies Ltd trimmed their revenue growth guidance for FY24.
Meanwhile, the December (Q3) quarter is seasonally weak for the sector due to lower number of working days. However, this time around the impact of furloughs could be deeper and wider as more verticals apart from BFSI and hi-tech struggle with muted demand scenario. Come Q4, the budgeting exercise at clients will be a crucial monitorable. Lower IT spending targets for 2024 by clients would be a headwind to FY25 earnings estimates.
Amid this, the focus will be on margins. With supply-side challenges out of the way, investors can expect some respite on margins. Levers such as better utilisation, lower sub-contracting and easing attrition rates could aid margins. Thus, averting steep earnings estimates downgrades (FY24/FY25) for IT companies. “We build in a 60-110 basis points margin expansion over FY2024-26E for TCS, Infosys and HCLT," said Kotak Institutional Equities.
Meanwhile, so far in FY24, the Nifty IT index has rallied by 12%. This is likely driven by expectations of better FY25. But the sustenance of this rally depends on whether H2FY24 throws up a negative surprise in the outlook for demand.
