Wage increments, travel costs key risks to margins for IT companies in Q1; here’s what to expect

The corporate result season for India Inc. is set to kick off this week with information technology major Tata Consultancy Services' earnings on July 8. There are expectations that wage increments, higher retention costs, increased travel costs and a drop in utilisation levels may hit the margins of the IT sector in Q1FY23.

Here’s all you need to know:

Stock market movement so far

With a fall of nearly 25 per cent, the BSE IT index has underperformed the benchmark equity index BSE Sensex (down 8.62 per cent) on a year-to-date basis till July 4. Barring Kellton Tech Solutions (up 11.64 per cent) and Tata Elxsi (up 37.75 per cent), as many as other 63 stocks in the sector have wiped off investors' wealth in 2022 so far. 

IT majors such as Tech Mahindra, Wipro, Mindtree, Infosys, TCS and HCL Technologies have retreated between 10 per cent and 45 per cent YTD. According to Emkay Global Financial Services, IT stocks underperformed due to higher odds of a recession in developed markets in the next 12-18 months.

What to expect?

Prabhudas Lilladher

Brokerage Prabhudas Lilladher believes that attrition will stay at elevated levels as IT companies roll out wage hikes in H1FY23. LTM attrition is expected to inch up. On a sequential basis, attrition is expected to stay stable. “We expect Infosys to maintain its revenue growth guidance of 13-15 per cent YoY CC and EBIT margin guidance of 21-23 per cent. We also expect HCL Technologies to maintain its guidance of 12-14 per cent YoY CC and 18-20 per cent EBIT margin band. However, cross-currency headwinds are likely to impact dollar revenue growth adversely across the IT pack in FY23,” the brokerage said.

In the case of TCS, Prabhudas Lilladher expects a 90-100 basis points QoQ decline in EBIT margin due to wage hikes, higher retention costs and an increase in travel costs.

Motilal Oswal Financial Services

The brokerage said that IT companies under its coverage should witness modest median dollar revenue growth in Q1FY23E (up 3.3 per cent CC QoQ and 14.3 per cent YoY). EBIT and PAT growth (-1.0 per cent and -2.8 per cent QoQ) should see further pressure due to wage hikes and continued supply-side pressure despite the depreciation of the rupee against the dollar.

ICICI Securities

ICICI Securities expects 2.3-4.3 per cent QoQ CC growth for tier-1 IT services. An assessment by the brokerage showed that Infosys to lead on the organic revenue front with a growth of 4.3 per cent QoQ CC, followed by TCS at 3.6 per cent QoQ CC. Growth in Tech Mahindra, Wipro and HCL Technologies are expected to be soft due to seasonal weakness and moderation in demand.

“Cross-currency headwinds of 100-200 bps will likely result in lower dollar revenue growth this quarter for all IT services companies. We expect 3-5.5 per cent QoQ CC growth for Tier-2 IT services and ER&D companies are expected to report revenue growth of 3.2-5 per cent QoQ CC. This will be another decent quarter for revenue growth and weak margins. All companies will face cross-currency headwinds from 5 per cent, 6.6 per cent and 1.7 per cent appreciation of dollar against EUR, GBP and AUD, respectively.

It further believes that Q1FY23 and Q2FY23 will be the peak for margin pressure and gradually margins will improve H2FY23 onward, but revenue momentum is expected to start softening from H2FY23 and also for FY24 on account of clients postponing spends, absence of large deal wins and softening deal win momentum ahead. 

“We believe IT spends are strategically important but not immune to macro pressures,” ICICI Securities said while maintaining its underweight stance on India IT sector as it sees peak revenue growth momentum behind, and thinks that deal and hiring momentum will likely soften.

Key things to watch

Market participants should zero in on the vertical-specific impact of weak macro or geopolitical uncertainties on tech spending, the pace of conversion of the deal pipeline, change of revenue and margin guidance for FY23, the long-term sustainability of demand and commentary on hiring (which is also a lead indicator of demand) and attrition.

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