IT sector to see lacklustre revenue growth with recovery in margins in 2Q

The poor revenue growth is seen as primarily driven by a broad-based disruption in global demand caused by the visible economic slowdown in the advanced markets of Europe and the US. 
Image used for representational purpose only (File Photo)
Image used for representational purpose only (File Photo)

The IT sector is staring at weak growth, with expectations of only modest revenue growth in the second quarter of FY2024, led by weakened decision-making processes and a generally lacklustre demand environment, pointed out several analysts. 

“2QFY24 is likely to be incrementally better than 1Q. But nowhere close to what most players
envisaged at year-beginning. Hopes of finding a bottom in 1H have not materialised, we
believe, as project ramp downs/cancellations continue,” said analysts from JM Financial. 

Analysts from Motilal Oswal also shared the pessimism. “The softness seen in Q1 should continue across the board with no meaningful signs of recovery or deterioration in Q2,” they noted. 

DEMAND HEADWINDS

The poor revenue growth is seen as primarily driven by a broad-based disruption in global demand caused by the visible economic slowdown in the advanced markets of Europe and the US. 

IT spending is likely to be constrained on account of persistent inflation and delayed rate cuts by the US Federal Reserve.

The overall growth environment in the IT sector is subdued, as indicated by the expected (1%) to +1% constant currency (CC) quarter-on-quarter revenue growth. 

“Large deal wins, though positive, is unlikely to contribute meaningfully to FY24 revenues. We therefore see potential guidance cut by both HCL (4-6% from 6-8%) and Coforge (12-14% from 13-16%) as a soft 2Q raises 2H ask materially,” it added. 

“Deal TCVs should look attractive with recent mega-deal wins for selective names,” said analysts from Motilal Oswal. 

“This growth rate is among the slowest observed over the last decade,” pointed out Motilal Oswal.

The Indian IT services industry remains dependent on the US and EU— the regions constitute nearly 86% of revenue share— with export growth mapping the GDP growth rates in these regions. 

The only solace for now comes from large cost take-out led deal total contract value (TCV), especially from Europe, continuing to surprise positively and could potentially alleviate a part of FY25F growth concerns, noted analysts from Incred Equities. 

“Deal win announcements, with a focus on cost take-outs, have picked up in the quarter, which should lead to sequential growth improvement in CY24, in our view,” it added. 

MARGINS

Unfavourable currency exchange rates are putting further pressure on their EBIT margins despite a conservative approach to hiring. 

Nevertheless, there are multiple factors that led to a cautious near-term outlook for many companies even as analysts maintain a structurally positive view of the sector looking at long-term prospects.

“..a focus on cost-control measures should lead to margin improvement in 2Q,” noted analysts from Motilal Oswal. 

Margin recovery is anticipated across the board following the completion of wage hikes. A strict emphasis on cost-controlling measures should support margins in the second quarter.

“The net headcount addition would be lower across the board, aligning with the demand trend. Additionally, companies currently possess sufficient talent to sustain incremental growth. The focus has now shifted toward optimizing bench strength to enhance efficiency,” noted Motilal Oswal 

Some IT companies, including INFO, HCL, and WPRO, have deferred wage hikes as a cost-saving measure.

“We expect sector Ebit margins to expand by 40bps QoQ, as annual wage hikes have been deferred by some companies amid easing supply-side,” noted IIFL Securities. 

Given the poor demand scenario, companies are not expected to have achieved significant margin expansion due to limited pricing power during the second quarter.

“We expect top-4 players to report (10)-50 bps EBIT margin expansion QoQ. TECHM’s
normalised margins (ex of one-time cost) will likely be flat despite reversing wage cuts for
senior management. LTIM/PSYS, owing to wage hikes, will see some margin contraction
while Coforge will report a healthy 150bps improvement,” said JM Financial. 

Cross-currency headwinds are limited to 0.3%. Ebit margins will expand by an average of 0.4% quarter-on-quarter, as wage hikes in some companies have been deferred amid favorable supply side, noted IIFL securities. 

Net hiring is likely to remain soft in 2Q, as companies look to deploy previously hired resources and are finding it easier to increase just-in-time hiring, it added. 

OUTLOOK

Given the weak 1HFY24, we see companies narrowing down their FY24 revenue guidance to lower end. 

However, CY24 growth can see improvement, as signed but stalled transformation deals as well as an increased number of cost takeout deals, start ramping up, with clarity on CY24 budgets in 3Q.

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