Rising employee costs hit margins of major IT firms in Q1

The COVID-19 pandemic had a huge impact on the technology industry, even though IT experts had not anticipated such a boom. The demand for digitization, artificial intelligence, data science, and cloud computing has grown significantly.

During the early stages of the pandemic, techies handled initial demand by working from home, but as tech demand and start-up funding skyrocketed, new companies began hiring techies and offering them massive pay packages in order to gain a market share in the digital space.

For context, the lockdown has shifted classrooms to online mode, and ed-tech companies have gained immense popularity post-lockdown. Many ed-tech startups have achieved a $1 billion valuation status and have turned into unicorns.

This has led to an unprecedented boom in the IT industry as a result of the increase in startups and a rise in order books of large IT firms at the same time. Companies have begun to race to acquire talent, which in turn leads to high attrition levels as techies move between jobs frequently.

Top IT companies began investing in salary adjustments, attractive salaries and benefits, stock options, various employee engagement activities, and solid talent management practices in order to retain talent.

For instance, tech giant Infosys Ltd. has also announced bumper raises, promotions, and bonuses to its employees to reverse record turnover levels as the company completes its limited pool of workers in digital, cloud computing, artificial intelligence, and data science. According to a report in the Mint, the company has decided to offer an average rise of 12-13 per cent to its employees in India. The company also offers a hike of up to 20-25 per cent for high-potential employees and also a retention bonus.

Overall, IT companies paid as much as 62% of their revenues as salaries in FY22, according to Business Insider India research. L&T Infotech was the most generous this year, along with its sister company Mindtree, while Tech Mahindra held on to its purse a lot more tightly.

TCS, Wipro, HCL tech and LTI, ended up with high salary growth when compared to revenue. This clearly shows that these companies spend more to retain existing talent or hire freshers.

Over the last five years, giants like TCS, Infosys and Wipro have maintained their salaries outflows at an average of 53-55%, while the smaller players like L&T Infotech (LTI) and Mindtree shelled out the most, between 60-63%. Yet again, HCL Tech and Tech Mahindra (TechM) emerged the most miserly, with an average outflow of just 51%, the report said.

Further, these seven IT companies earned nearly ₹5.5 lakh crore in revenue in FY22 and paid out ₹3 lakh crore in salaries. In total, over the last five years, these companies earned nearly ₹22 lakh crore and paid out nearly ₹12 lakh crore in salaries.

Higher employee costs increased overall expenses

On Wednesday, IT major Wipro Ltd reported a 20.6 per cent YoY decline in consolidated net profit at ₹2,563.6 crore for the quarter ended June as higher employee costs pushed up the overall expenses. Wipro's total expenses increased by 22.9% to ₹18,648 crore.

Similarly, TCS’ total expenditure during the June 2022 quarter jumped 19.95 per cent to ₹40,572 crore, compared with ₹33,823 crore in the corresponding period last year. Its employee costs also rose 18.23 per cent, to ₹30,327 crore, against ₹25,649 crore.

TCS reported an operating margin of 23.1% in the June quarter, 190 basis points lower than a year ago and 240 basis points lower than the previous quarter. According to TCS CFO Samir Seksaria, the dollar's strength against most currencies increased margins by 25 basis points. But all that was negated by the increase in wage costs, TOI reported.

Meanwhile, HCL's operating margin for the April-June quarter fell 90 basis points sequentially to 17%, dragged down by increased travel and manpower costs amid all-time high attrition in the services business.

Downgrades

The Indian IT sector was hit by concerns over the recession, rate hikes, and downgrades from global brokerage firms. Several global brokerage firms have trimmed their targets for Indian IT companies.

Recently, Jefferies downgraded selective IT stocks due to recession fears in the US. Jefferies downgraded HCL and Tech Mahindra to hold and Wipro, LTI, and Mindtree to underperform. However, it picks Infosys as its top pick with a target price of ₹1,700 given its sector-leading growth and strong execution. Further, it maintains a 'hold' rating on TCS despite the stock's rich valuations.

Jefferies notes that over the past 20 years, US real GDP growth has fallen to 0% twice, and in both cases, global IT services spending has seen marked growth moderation.

So far in 2022, the Nifty IT index has dropped 27 per cent. In the last three months, the index has dropped approximately 4,269 points, falling to 28,342 from 32,611.60. Further, the IT index has dropped 28.14% from a record high of 39,446.70.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of MintGenie.