IT results mixed bag, but hiring remains robust in September quarter

Revival of spending by BFS & retail clients may take some more time

Hiring continued to remain robust in the IT sector, which was driven by strong deal wins, even though IT services companies reported mixed numbers in the September quarter. 

In the first six months of FY20, the IT services space saw net addition of 64,442 jobs, around 27 higher than the corresponding period in the previous fiscal.

TCS led the pack in terms of net hiring of people, adding 14,097 in Q2FY20 alone followed by Infosys, which added 7,457 during this period. Both the companies claimed to have signed deals with the highest total contract value (TCV).

Overall, performance of the sector was bit of patchy with rising costs and depreciating rupee eating into the margins of some companies while verticals such as retail and banking and financial services (BFS) remained a pain point for most. 

Analysts tracking the sector are of the opinion that while the next two quarters (H2, FY20) are expected to be generally soft, the sector is expected to perform better in FY21 and beyond when revenues from the recent deal wins start flowing into their balance sheet. “Lower profitability is due to a couple of factors like increase in US operations cost structure in the form of higher subcontracting and higher localisation due to talent shortage  as well as tightening of the visa regime. There are also transition costs in large deals,” noted Kawaljeet Saluja, Research analyst, Kotak Institutional Equities. 

Saluja added that while earnings before interest and taxes (Ebit) margins were largely in line on a sequential basis, they declined 50-380 bps on a year-on-year (YoY) basis. TCS’ Ebit margin was relatively flat at 24 per cent, mainly due to increase hiring costs. Even though Infosys surpassed margin expectations, it was primarily driven by its near peak employee utilisation numbers. Among the top tier firms, Wipro surprised the Street with improved margins led by lower expenses and subcontracting costs. For Tech Mahindra, the management has indicated that H2 margins will remain subdued due to transition costs. 

According to experts, the overall spending has pockets of softness, especially in financial services in Europe, capital markets in the US and the retail vertical and large deal momentum. Since most headwinds are across retail and financial verticals, Tech Mahindra looks better poised for growth compared to others as it has lower exposure to these sectors. 

The banking, financial services and insurance (BFSI), a key vertical, grew in the range of 3 to 10 per cent YoY for tier-I companies. TCS, Infosys (on organic basis) and Wipro reported modest growth in the vertical with low expectations of improvement in spending by banking clients. 

Among the top five IT firms, Tech Mahindra is said to be better poised for growth in the coming quarters compared to others as it has lower exposure to the retail and BFS verticals.

A common concern across-the-board has been the pricing pressure in legacy, increasing employee cost due to higher localisation, and lack of pricing power in case of new deals. 

“Margin pressure that firms have been facing is largely due to the absence of natural hedge from rupee depreciation that used to balance the wage hikes (usually given in H1), large deal transition investments and increasing onsite costs,” said Amit Chandra, research analyst, HDFC Securities. “But large deals tend to be less profitable in the first couple of years and then start giving returns,” he added. 

Digital services continued to be one of the strong growth segments for the IT services players. In Q2, Infosys reported a 31 per cent YoY growth in digital that accounted for 25 per cent its overall revenues, driven by cloud, data and analytics, internet of things (IoT) and customer experience (CX). TCS reported 25 per cent growth in digital with a strong emphasis on longer duration and large-ticket deals. However, TCS’ growth in digital services seems to have moderated a bit owing to a larger revenue base, according to the management.