scorecardresearchTCS, Infosys show common factors of pain; what lies ahead for the IT sector?

TCS, Infosys show common factors of pain; what lies ahead for the IT sector?

Updated: 17 Apr 2023, 06:57 PM IST

The IT sector has to deal with the slowdown in the US market. While it was expected, the slowdown was sharper and got exacerbated by the recent banking crisis in the US and Europe.

Brokerage firm Kotak Institutional Equities expects FY24 to remain weak for IT firms.

Brokerage firm Kotak Institutional Equities expects FY24 to remain weak for IT firms.

The March quarter (Q4FY23) results of Infosys and Tata Consultancy Services (TCS) appear to have disappointed the Street.

TCS reported its Q4FY23 earnings after market hours on April 12. The stock has been in the red since April 13. Infosys declared its earnings after market hours on April 13 following which, the stock fell over 12 percent to its fresh 52-week low of 1,219 in the next trading session on April 17.

As Mint reported, TCS posted a 14.8 percent year-on-year (YoY) and 5.03 percent quarter-on-quarter (QoQ) growth in consolidated net profit to 11,392 crore in Q4FY23. Revenue from operations stood at 59,162 crore, up by 16.94 percent YoY and 1.6 percent QoQ. The net margins stood at 19.3 percent, while operating margins came in flat at 24.5 percent.

Analysts expected a net profit of around 11,530 crore on average for the said quarter.

On the other hand, Infosys' revenue increased by a smaller-than-expected 16 percent to 37,441 crore in the fourth quarter of FY23, while its profit of 6,130 crore also missed analysts' expectations. Analysts expected a profit of 6,613 crore.

A slowdown in the US is a common challenge for both companies.

As brokerage firm Kotak Institutional Equities highlighted in its report: "TCS and Infosys’ earnings prints had two common factors: (1) deterioration in demand from North America with discretionary programs that were paused or cancelled and (2) an inability to flex margin levers as near-term costs are sticky at the beginning of the slowdown."

The brokerage firm, however, added that its structural view on margins and growth has not changed, even as it recognizes elevated headwinds that could feed into multiples in the near term.

What lies ahead for the IT sector?

The sector has to deal with the slowdown in the US market. While it was expected, the slowdown was sharper and got exacerbated by the recent banking crisis in the US and Europe.

"The banking crisis in US regional banks and European banks in March 2023 has induced greater caution and could impact the June 2023 quarter. We would not be surprised by a weak US performance across companies that are likely to report in the coming days," said Kotak.

Kotak expects FY24 to remain weak for IT firms.

However, there is hope that the adoption of cloud-native applications will increase which will augur well for IT service providers.

"Workloads on the cloud are still 30-35 percent and will require additional two-three years to reach the desired 60-70 percent levels. We expect the adoption of cloud-native applications to increase as more IT workloads move to the cloud," Kotak said.

"There are plenty of exciting technologies, such as IoT (internet of things), big data and deep learning AI (artificial intelligence), that lend themselves well to cloud environments. Analytics and big data on the cloud are already seeing massive adoption. These can sustain healthy growth for IT services beyond the cloud migration phase," added Kotak.

Brokerage firms highlight while the quarterly numbers show that BFSI vertical growth for IT companies has been significantly lower, the core modernisation and digitisation plans of BFSI companies remain intact which could result in a sharp pick-up in the vertical's revenue in FY25 and FY26.

"We have already factored in a slowdown in the BFSI vertical for IT in the calendar year 2023 due to macro-slowdown, wherein banks’ profitability may come under pressure due to weak credit growth in the economy. Therefore, we have assumed soft revenue growth in the BFSI vertical in FY24E followed by a sharp pick-up in FY25E and FY26E because we believe core modernisation and digitisation agendas of BFSI companies remain intact," said ICICI Securities.

"In a recessionary scenario, there is an increased focus of clients on IT outsourcing and cost optimisation, which are the key strengths of Indian IT vendors. In such situations, market share gains accelerate for these players on account of vendor consolidation and potential buyout of captive F500 (Fortune 500) or G2000 (Forbes Global 2000) enterprises. We continue to prefer TCS (buy), Infosys (Buy) and LTIMindtree (buy)," it added.

What analysts say

Vinod TP, Research Analyst at Geojit Financial Services

Despite the Q4 results being below expectations, there are potential growth drivers in the form of cloud and digital transformations, as well as strong deal pipelines in certain areas.

We had a neutral rating on the IT sector due to high valuation and low earnings growth under the risk of recession in the US. However, the consolidation of the IT sector in the last 15 months has moderated the valuation risk.

Now we think that a long-term investor can consider implementing an accumulation strategy in the IT sector. Industry valuation has reduced to a five-year average, though volatility is expected in the short term.

Urmi Shah, Research Analyst at SAMCO Securities

Sentiment remains pessimistic as clients are delaying discretionary spending. BFSI and retail are some sectors where soreness can be felt in the coming times. Geographically too, America and Europe have continued to witness a weak market.

Given the top IT giants have given cautious guidance for the coming year, the sector is expected to remain choppy for the coming quarters. The sector continues its plan of slower hiring and costs optimisation measures but the same has not yet displayed any fruitful results.

All in all, uncertainty prevails in the macro-economic environment putting pressure on revenue growth. While normalising attrition can be a factor contributing to margin expansion, slower growth can weigh down the same.

Aamar Deo Singh, Head Advisory at Angel One

Post TCS, Infosys results, IT stocks have corrected sharply, on the back of investor fears of a slowdown, with clients from the US and Europe, adopting a more cautious approach.

Uncertainties in the US economy are one of the primary reasons for this, and it isn’t very likely to be resolved anytime soon. Investors are expecting muted growth in the coming quarters until a clearer picture of the global economy, particularly the US and Europe, emerges.

Sonam Srivastava, Founder of Wright Research

The Q4 results of TCS and Infosys have missed Street estimates amid global uncertainties. This has set a subdued tone for the IT sector's Q4 performance. Experts predict the next one-two quarter will be choppy for the industry but are hopeful of a subsequent recovery.

The management commentary from India's top two IT services companies has cautioned about customer sentiment across BFSI, technology services, and other verticals, particularly in the US. Factors like unplanned project ramp-downs, customer decision-making delays, and clients deferring non-critical initiatives have contributed to the weak performance.

Industry experts see a cautious Q1FY24 and expect growth to return in Q2FY24. Uncertainties in the US market may decrease in the April-June quarter. Still, new work could take another one-two quarters to materialise, indicating that October-November might be a better time for the industry.

While the softness in earnings may continue for a few quarters, growth is expected to return as the US economy remains robust post-Covid, and clients sign up for big contracts to further reduce costs. However, the slowdown in the BFSI segment, which is high on the digital maturity curve, may mute growth for IT over the next three to four quarters.

Divam Sharma, Founder at Green Portfolio PMS

With a high probability of recession in the US, UK, and many European countries, we see uncertainties continuing around the order outlook for the next one-two quarter.

However, some good value opportunities are gradually emerging in the sector. Infosys is now trading at a PE multiple of 21.2 times, anything below 19 times is a great opportunity for investing in the stock.

S K Hozefa, CEO of Tradeplus

The Indian IT industry is projected to grow faster than the country's economy in the financial year 2023-24, despite subdued sentiment and longer decision-making cycles leading to cost-optimization measures.

Nasscom has estimated that India's export revenue in the sector will rise by 11.4 percent in constant currency terms to $194 billion, with an incremental revenue addition of $19 billion during the same period.

The industry is expected to touch $245 billion, with the IT sector contributing 10 percent to India's GDP, by 2025. The US and APAC remain key markets, growing at 10.4 percent and 10.1 percent, respectively, while growth in Europe has been slower at 7.3 percent.

The industry experienced slower growth in core sectors such as BFSI, manufacturing, and telecom/hi-tech, but ER&D, IT services, BPM, and products among business segments continue to see growth.

The pandemic has highlighted the importance of technology, as businesses require technology to run, and digital transformation across sectors and business sizes will keep demand for Indian IT services strong.

Although IT spending may moderate in the near term, maintenance of existing IT infrastructure is necessary. Investors can consider the IT sector for diversification and long-term strategies.

The industry's focus is on investing for growth, propelled by forward-looking policies, strong governance, talent, and digital trust to ensure accessibility, privacy, security, and reliability.

The tech industry in India is on track to accelerate growth to $500 billion by 2030, driven by technology spending, but headwinds are strong, and the outlook for the 2023-24 financial year looks similar.

Disclaimer: The views and recommendations given in this article are those of individual analysts and broking firms. These do not represent the views of MintGenie.


India's digital economy growth
First Published: 17 Apr 2023, 04:27 PM IST