Q3 results: IT firms to shed light on rocky road ahead

It can very well be a winter of concerns.

After basking in the sun for the last two years on the back of the pandemic-induced demand surge, Indian IT firms have begun preparing for a period of moderating growth as enterprises hold back technology spending amid recessionary fears.

Their third-quarter report cards and subsequent management commentary this week will provide the first glimpse of the rocky road ahead.

Indian IT firms are likely to see a moderation in revenue growth, a marginal uptick in operating margin, a fall in employee attrition and a slackening deal pipeline for a seasonally weak October-December quarter, analysts told DH.

“As we are forecasting a slowdown in 2023, many enterprises are likely to be on a ‘wait and watch’ mode. So, the pipeline of several large transformation projects may hit a slow lane,” said Ashish Chaturvedi, Practice Leader (Supply Chain, Retail/CPG, Disruptive Tech), HFS Research.

Bigger IT companies will, however, do better than their mid-tier rivals on the deal-making front, as some of their clients look to find ways to cut costs, he said.

Subdued growth

The third quarter has traditionally been a seasonally weak period.

Industry watchers expect the latest third quarter to be weaker due to more furloughs, high inflation in key markets such as the US and Europe, and softness in key verticals.

“We expect revenue growth to moderate sequentially (after strong growth in the first half of the financial year) on higher-than-normal furloughs, fewer working days, deferred spending from some clients, and a high inflationary environment,” ICICI Securities wrote in a note.

The brokerage expects the IT firms to post sequential revenue growth in the range of 0.5 to 3.5 per cent during the quarter in constant currency terms. HCL Tech is expected to lead the show among Tier-1 firms with 2.5 per cent revenue growth, followed by Tata Consultancy Services and Infosys.

Among tier-II IT firms, Coforge & LTIMindtree (that will announce consolidated numbers post-merger) are expected to post a 3.5 and 3 per cent sequential rise in revenue in the period.

Infosys and HCL could maintain their revenue and margin outlook for the financial year despite the slowdown concerns, the brokerage said.

Third-quarter operating margins could see a marginal uptick on the back of falling employee attrition, rupee fall, and higher utilisation, analysts said.

They also expect attrition numbers at IT firms to fall in absolute terms amid layoffs at global tech giants and in the Indian startup world. “We should see employee attrition numbers falling in the third quarter on an LTM (last twelve month) basis,” said Supaul Chanda, vice-president of technology recruitment firm Experis of Manpower Group.

Many industry experts also expect employee utilisation to improve as freshers onboarded in the first half of the year are assigned projects after their training ends.

These factors will support the operating margin along with the fall of the rupee against the US dollar. The softening of the US dollar against other major currencies during the quarter would also minimise the cross-currency challenges.

“EBIT (earnings before interest and taxes) margin is likely to expand by 0.2-1 per cent sequentially for tier-1 companies and 0.2-0.5 per cent for tier-2 companies on account of operating efficiencies, employee pyramid rationalisation, moderation in attrition, and rupee depreciation,” Emkay Global wrote in a note.

However, LTIMindtree might see an adverse margin impact owing to one-off costs arising from integration.

The deal pipeline during the quarter is expected to slacken with much divergence coming out among large and mid-tier companies. Sources in the know said even within tier-I companies, some companies are expected to post healthy growth in order bookings on the back of some large deal wins.

They pointed out many mid-tier firms will report a 20-30 per cent fall in their order books for the quarter, which will be an early indication of things to come in the coming year.

All eyes on management

With TCS kickstarting the earnings season on Monday, investors will keenly watch management commentary on their clients’ technology budgets, deal pipeline, the nature of deals (cost takeout or digital), demand trends in key verticals such as banking and retail, pricing power and supply-side issues.

“Orderbook trend will set the tone for FY24. So, it will be important to gauge whether flows of cost-takeout deals have begun or they are yet to translate. As December-January is the period of client budget finalisation, IT firms will provide some clarity on this aspect,” said Pareekh Jain, founder of Pareekh Consulting.

“Views on specific geographies like the US and Europe depending on exposure and verticals will also be keenly watched,” he said.