IT firms may log muted growth in Q1, see 50-160 bps decline in margins

Margin growth in the absence of benefits from rupee depreciation will be a concern, say experts

Indian information technology (IT) services firms are expected to log muted growth in the April-June quarter (first quarter, or Q1) of 2019-20 (FY20), while profit margins are expected to shrink further.

Factors such as increasing visa costs, wage hikes, shortage of talent in key geographies, as well as transition costs associated with large deals, are expected to adversely impact revenue as well as profitability of the players in this segment.

Experts tracking the sector say that the top-tier IT services firms are expected see 50-160 basis points (bps) decline in their margins, while companies such as Tata Consultancy Services (TCS), Infosys, and Tech Mahindra (TechM) may see margins shrinking by over 100 per cent.

Among large-cap IT firms, analysts expect TCS and Infosys to lead the pack, with up to 3 per cent constant currency revenue growth in the digital segment. Wipro and TechM are expected to post sluggish growth, while HCL Technologies’ (HCL Tech’s) purchase of intellectual properties from IBM is not expected to be reflected in their financial numbers until the second quarter of FY20.

“We expect Q1FY20E to be a mixed quarter for Indian IT services, with TCS and Infosys likely to post steady revenue growth in tier-1, and Hexaware, Mphasis, L&T Technology Services (LTTS) to post steady revenue growth in tier-2 IT services,” wrote Aniket Pande, research analyst Prabhudas Lilladher in a report.

The report further expects TCS, Infosys, Wipro, and HCL Tech to post currency revenue growth of 3.2 per cent, 2.5 per cent, 1.6 per cent, 1.5 per cent, respectively, while TechM is expected to see a decline of 0.7 per cent. 

Among small-cap IT companies, Hexaware, Mphasis, and LTTS are expected to deliver steady revenue growth, whereas Larsen & Toubro Infotech, Cyient, and Mindtree may post flat revenue growth, owing to client-specific issues. 

One of the key concerns cited by analysts for this quarter is cost pressure. Companies such as Infosys, HCL Tech, and TechM are likely to face some cost pressure, following the transition of a number of large deals reported over the past year, which is likely to impact margins as well.

“We note that a significant rupee depreciation and acceleration in revenue growth provided a cushion for margins in 2018-19. These factors are not available to offset headwinds in FY20E. Rupee depreciation is critical to defend margins; else there are downside risks to profitability in FY20E,” noted Kawaljet Saluja, analyst Kotak Securities. He factored 20-340 bps year-on-year decline in earnings before interest and taxes margin for large-cap IT companies.

Factors like decline in H1B visa approvals and increasing investments in business, including acquisitions, will also their impact revenue growth. Financial services firms in the US and Europe, towards the end of calendar year 2018, had increased focus on cost-management initiatives in the face of an uncertain global environment. This, along with a few client-specific issues such as mergers and acquisitions, and leadership changes at client organisations, had led to some softness in IT spending, especially in the capital markets segment in Europe in the March quarter. Commentary on all of these concerns will be closely tracked.

Motilal Oswal analysts expect that despite the base effect of large deal ramp-up (communications) in the previous quarter, Infosys is estimated to deliver 2.3 per cent quarter-on-quarter constant currency growth, based on the deal wins and the revenue coming from the Stater NV acquisition.