Margin pressures for IT companies in March quarter as business costs rise

Revenue growth, however, is expected to be robust due to a strong deal pipeline.

The software sector's revenue grew in the March quarter, but it is expected to report pressure on margins due to higher costs and an appreciating rupee.

In a traditionally weak quarter, top tier IT companies are expected to post sequential revenue growth of 1.5 per cent to-2 per cent on the back of recent deal wins and execution of the same.

However, margins are expected to be weak due to higher costs. Amit Chandra, of HDFC Securities, said there are headwinds for profitability. Higher onsite or localisation of operations coupled with lower H-1B employee count is expected to increase staff costs. 

Multinational companies opting for captive centres has increased demand for digital workforce in the domestic market, causing attrition and higher reskilling costs. IT companies are increasingly relying on subcontractors to deliver digital contracts at on-site locations. Subcontracting costs have risen sharply over the last two years impacting margins of top-tier companies.

These costs as a percentage of revenue account for as much as 16 per cent for Wipro, while it accounts for 8 per cent to 12 per cent for others. 

Margins could also be under pressure given the strengthening rupee. The Indian currency has appreciated by about 2 per cent in the March quarter as compared to the December quarter. While favourable cross currency tailwinds are positive, they are offset by the sharper rupee gains against the greenback. 

Among top IT companies, margins for Infosys, according to Nirmal Bang Institutional Equities, is expected to trend down to the lower end of the 22-24 per cent band given the investments in digital, large deal transition costs and likely dilution from a few of the joint ventures it has signed. Margins for TCS which were lower than expectations in the December quarter are expected to be stable in the March quarter. 

In addition to March quarter performance, the street will also keep a close eye on revenue and margin guidance for FY20. Most companies are expected to guide for a 8-11 per cent revenue growth due to strong deal pipeline. More importantly, the pressures due to wage hikes across companies and high visa costs will keep margins under pressure even in the June quarter.