BackMargin pressures may offset revenue gains of IT firms in Q1
Covid-led increased cloud adoption is expected to keep the sector’s deal pipeline and bill-to-book ratio robust. Major deals signed in the June quarter include TCS-Proximus, HCL Technologies-Hitachi ABB and Infosys Ltd-energy giant BP
PremiumThe good news for investors in IT stocks is that the strong deal win momentum of FY21 will continue this fiscal. Covid-led increased cloud adoption is expected to keep the sector’s deal pipeline and bill-to-book ratio robust. Major deals signed in the June quarter include TCS-Proximus, HCL Technologies-Hitachi ABB and Infosys Ltd-energy giant BP.
Ramp-up of large deals won in the recent quarters, increased traction in digital services and ongoing recovery in verticals such as travel, hospitality and manufacturing would aid revenue growth. Tier-1 IT firms are estimated to see sequential organic revenue growth of 2-4% in constant currency terms. For tier-2 firms, this is expected to be in the range of 3.5-7%.
Further, the FY22 revenue growth outlook is also likely to be strong in double digits for TCS, Infosys and HCL Tech. Infosys, which gives an annual revenue guidance, is expected to marginally increase the target it had set three months ago.
While robust revenue growth could translate into revenue upgrades, decline in operating margins could keep earnings revisions under check. Rise in attrition, decline in utilization rates and salary hikes are seen as threats to the IT firms’ operating performances in Q1FY22. “We expect Ebit margin to remain under pressure across firms due to the salary hike cycle, moderation in utilization, uptick in attrition and higher recruitment costs as the war for talent intensifies. Though the demand environment stays strong, supply-side challenges might impact margins," said analysts at Emkay Global Financial Services.
TCS, L&T Infotech Ltd, Tech Mahindra Ltd and Mindtree Ltd have undergone regular increment cycles in Q1FY22. So, analysts expect full impact of salary hikes to come for these firms in the June quarter. Also, attrition levels are expected to be higher for firms that have completed wage hikes in the last quarter.
As far as the utilization rates are concerned, they remained abnormally high in the past two quarters, so analysts expect that trend to normalize. Other expenses related to travel and marketing are also expected to start inching up from Q1FY22. The management’s commentary on measures to deal with the increased cost pressure will be one of the key monitorables.
According to analysts at Kotak Institutional Equities, “There is a literal war for talent with compensation increase for ‘in-demand’ skills of more than 20%. Demand is a given, ability to staff projects is not." In this backdrop, investors will watch out for commentary on the pricing environment and whether they are able to pass on costs to customers.
The IT services sector was one of the key beneficiaries of the pandemic. The Nifty IT index saw a massive rally of 102% in FY21, outperforming the Nifty50 index, which jumped around 70% in the same span.
As for valuations, analysts say that Nifty IT’s one-year forward price-to-earnings multiple of 26 times is around 50% higher than its long-term average.
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