Analysts see dull growth for Indian IT companies as US combats coronavirus

IT companies earn over 50 per cent of their topline from the US.

With the spread of coronavirus or COVID-19 remaining unabated, major global central banks have intervened to soften the pandemic’s economic impact by reducing interest rates or by quantitative easing (infusing cheap funds). While the Reserve Bank of India (RBI) on  Monday announced measures to ease liquidity in the domestic banking system, the US Federal Reserve on Sunday cut its interest rate near to zero. 

While the jury is out on how much these efforts may help, the weakening demand environment has cast a shadow for major Indian information technology (IT) players, given their dependence on US financial services and the retail and energy sectors.

Top IT players — such as Tata Consultancy Services (TCS), Infosys, HCL Technologies, and Wipro — earn 21-32 per cent of their revenue from the BFSI (banking, financial services and insurance) sector and the US accounts for over 50 per cent of their top line.
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Toeing the broader market movement (the Nifty is down 24 per cent in the last one month), the Nifty IT index has also lost over 25 per cent, touching its 52-week low on last Friday, despite a weaker rupee being favourable for domestic IT players.

Amit Chandra, analyst at HDFC Securities, said: “Amid a likely negative impact of interest rate cuts by banks globally, including the US Fed, Indian IT players could see a flattish growth in the first half of FY21 (April-September 2020), in constant currency terms. This, in turn, would make achieving higher-single digit revenue growth in FY21 difficult for major IT players.”

Other analysts, too, have similar views. Sanjeev Hota, head of research at Sharekhan, said: “With sharp rate cuts in the US, which would impact the spending of BFSI clients, and lower discretionary spending in certain verticals amid the coronavirus pandemic, it looks challenging for Indian IT companies to achieve higher-single digit growth in FY21.”

Lower interest rates, along with the impact of coronavirus on corporate earnings, are likely to hurt IT spending in the BFSI sector, mainly banks. This could have a negative impact on Indian IT players in two ways -- the conversion of existing deals into revenue would get delayed and new deal size would come down. There could also be pressure on margins as clients seek more bang for the buck. In fact, coronavirus has only added to the woes for BFSI vertical, which was already seeing pain in the past few quarters. Many IT companies had reported negative growth in the BFSI verticle in the December 2019 quarter, on a sequential basis.

Not only from BFSI, but the growth pain would also stem from the retail segment, the second-largest business vertical (15-17 per cent of revenues) for some IT players. This is because, major the US- and Europe-based retail stores are closed to curtail the coronavirus spread.

 Some analysts also see pressure on the energy segment because of the crash in crude oil prices as this will impact energy projects. Companies like Infosys and Wipro derive up to 13 per cent of revenue from the energy segment. Additionally, travel restrictions may also weigh on the overall performance of IT companies.

On the downslide

Muted demand or IT spending is also expected to impact margins despite the rupee’s depreciation. Likely discounts by IT companies to get deals would curtail margin benefits from the rupee's depreciation to a great extent, says an analyst from a domestic broking house. Thus, even as one may expect some margin push in the March 2019 quarter from the rupee depreciation, how IT companies protect their margin in the next financial year would be the key.

Overall, investors are recommended to wait until more clarity on the top-line and margin fronts emerge. In view of these developments, some analysts said that they have cut their FY21 top-line and earnings estimates for domestic IT companies by 6-7 per cent and up to 8-10 per cent, respectively.