Deal wins, digital demand put IT companies back on growth track

Margins too surprised positively on higher offshoring and utilisation

Large deal wins, a sharp expansion in margins, and expectations of a return to double-digit growth were the key themes in the December-quarter performance of the top four IT firms.

Without exception, the top four majors beat Street estimates across all parameters — revenues, profitability, or net profit growth.

However, what stood out were the large deal wins reported by the big two, Tata Consultancy Services (TCS) and Infosys. While TCS got deals worth $6.8 billion in the quarter, the clear outlier has been Infosys. The company reported a large contract value of $7.13 billion, its highest ever; half of this was on account of a multi-year agreement with German auto major Daimler. 

For TCS, large deals included those with Prudential and Deutsche Bank. 

Wipro, which reported its contract value for the first time in a quarter, won deals of $1.2 billion.

Deals announced in previous quarters and digital uptick helped Infosys report the highest growth (among the top four) of 5.3 per cent on a constant currency basis. 

TCS, too, posted strong growth led by a broad-based uptick across its key verticals. On an annual basis, HCL Tech crossed the $10-billion mark in sales for the first time in CY20. Infosys and HCL Tech also revised their revenue and margin guidance upwards for FY21 and Q4, FY21 respectively. 

Amit Chandra of HDFC Securities said: “Infosys surprised the Street with higher than expected large deal wins. The strong deal pipeline across the IT majors, and acceleration of decision making after being put on hold in the June quarter point to robust growth visibility for the top four IT majors in FY22.”

Given the deal momentum, both TCS and Infosys indicated they would post double-digit growth in FY22. With analysts expecting Wipro and HCL Tech to also grow above 10 per cent, the coming financial year could be the first since FY14 when the sector reverts to double-digit growth.

Global IT research and advisory firm ISG, which tracks deal flows, highlighted the December quarter was the best ever in terms of annual contract value. 

In addition to digital services, which are expected to grow at over 20 per cent, the firm expects the traditional (legacy) services to also grow at 3 per cent for CY21. The top four Indian IT firms reported a single-digit YoY decline in the legacy segment, which accounts for half the revenues for them.

The other key takeaway in what is a seasonally weak quarter, given the furloughs, was margin performance. Barring Infosys (slight expansion), all the other companies posted a significant improvement in margins. Wipro had the best sequential growth in margins to 21.7 per cent, which is the highest in 22 quarters. 

While costs will play catch-up, analysts say some of the margin gains are structural and should sustain over the medium term. Near-term margins, however, could see some pressure, given wage hikes in the current quarter and annual increments in April.

The revenue and margin performance also helped companies such as Infosys and HCL Tech post their highest ever net profits. This, coupled with high cash conversion, will allow the top IT companies to maintain their dividends or use funds to acquire and invest in digital capabilities. 

Analysts expect the large Indian IT vendors to be the key beneficiaries on the back of market share gains, vendor consolidation, and captive monetisation. This is expected to help them sustain premium valuations. 

Suyog Kulkarni of Reliance Securities said: “The Nifty IT index could trade at premium valuations, driven by a double-digit revenue growth outlook, a stable Ebit (earnings before interest and tax) margin, and consistent cash return policies.”