A widely held expectation on the Street was that margin pressure for information technology (IT) services companies had eased in the September quarter (Q2FY23). Accordingly, earnings before interest and tax (EBIT) margins of IT companies were expected to improve from Q3 onwards. It has been played to an extent. Among the tier-1 IT companies that announced their Q3 results, barring Infosys Ltd, others have seen sequential growth in their Ebit margins. The accompanying chart shows the details.
Sector major Tata Consultancy Services Ltd’s (TCS) Ebit margin increased 50 basis points (bps) sequentially to 24.5% in the third quarter. TCS is confident of achieving 25% EBITDA by Q4 FY2023. One basis point is 0.01%. Close peer Infosys’ margin remained flat at 21.5 per cent. The company has retained its FY23 margin guidance at 21-22% and expects it to be around the lower end of the band. According to Investec Capital Services (India) Ltd, Infosys’ margins could potentially decline in Q4, in line with historical trends. However, there is scope for margin improvement through FY24/FY25 due to better utilisation, with lower attrition and lower sub-contracting costs, possibly in FY24. “Overall, we estimate 40/50 bps improvement in Ebit margin in FY24/25E,” Investec reported.
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HCL Technologies’ margin grew 170bps sequentially to 19.6%, helped by a strong performance from its software segment. The management has reduced the upper end of its FY23 margin guidance by 50bps to 18-18.5%. Jefferies India expects HCL’s margin to remain in the range of 18-19% over FY23-25.
Wipro Ltd saw IT services margin expand to 16.3%, beating consensus estimates. This astonishing margin was despite pay increases and promotions and was aided primarily by pyramid rationalization and automation. Wipro’s management believes that Q3 margins will be the new ground here.
“Comment by Tier-1 IT management was mixed on the demand front and points to some near-term caution and delay in customer decision-making, so investors can take solace from the fact that at least margins are starting to improve.” has happened, especially as supply-side pressures are easing,” said an analyst with a broking firm, requesting anonymity.
A combination of positive factors led to an expansion in the margins of Tier-1 IT companies. These include improved operational efficiencies, freshers becoming billable and favorable cross currency movements. Also, with multiple levers such as lower attrition, the margin outlook for tier-1 companies is likely to improve.
Considering that the third quarter was a seasonally weak quarter for the sector, sequential constant currency revenue growth was not as bad as previously estimated. That said, revenue visibility for FY24 remains lacking. Also, companies have indicated weakness in segments like mortgage, retail and hi-tech.
Indeed, the improvement in margins is a bright spot amid fears of a slowdown and lack of demand. However, for now, this is not enough to trigger a revival in the performance of IT stocks. In calendar year 22, shares of tier-1 IT companies gave disappointing returns with the sector index Nifty IT falling 26%.
“The shift to tier-1 IT stocks will be gradual and will depend on how the FY24 revenue outlook shapes up. “The expectation is that a shallow recession will hit the industry and it may last for a few quarters,” said Onkar Tanksale, senior research analyst at Axis Securities Ltd. Term, IT stocks will not see a sharp rise.
Of course, valuations of Tier-1 IT firms have come down from recent highs. But given the uncertainty, low valuations hardly offer much relief.
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