Companies
The good, bad and ugly: Decoding the IT pack’s Q4 show
Summary
- As the original sunrise sector of post-liberalization India, the IT industry has been the crowning jewel of the domestic economy for decades. A job in the IT sector has been, often literally, the passport to a better life for millions of young graduates. Is this paradigm changing?
New Delhi: "When sorrows come, they come not single spies, but in battalions."
—William Shakespeare, Hamlet
The higher the climb, the harrowing the descent.
If there is one sector which is experiencing this truism, it is information technology.
From the heady days of the pandemic-triggered digital boom, to the current slowdown due to growth headwinds in the West, the country’s $250-billion IT sector has traversed a full cycle over the past few quarters.
Elevated interest rates and weak consumer sentiment in the US and Europe—the bread-and-butter markets for India’s software services exporters—have wreaked havoc on the sector’s performance.
Add to that, generative artificial intelligence (GenAI) is precipitating an epochal shift in the industry and beyond, further queering the pitch for firms more reliant on legacy processes and models.
Investors, meanwhile, are divided on whether to take a contrarian bet on the embattled sector or wait for the storm to pass.
IT firms’ March-quarter numbers provide the perfect opportunity for stakeholders to assess not only their current predicament but also gauge the managements’ expectations for the immediate future. Here’s the good, bad and ugly of the IT sector’s fourth quarter (Q4) performance so far.
The Good
Deal wins: One of the most heartening trends of the Q4 results was that despite uncertain macroeconomic conditions, companies’ deal wins remained robust.
India’s largest IT services company, Tata Consultancy Services (TCS), logged its highest-ever deal wins at $13.2 billion (up 32% year-on-year), while that of Infosys stood at a healthy $4.5 billion—the only silver lining in an otherwise dismal set of numbers. More importantly, the key deal wins came across industry verticals and geographies.
“IT firms have been reporting record deal wins for the past three-four quarters now. It shows that India’s IT sector has been maintaining its market share dominance, not just currently but this has been the story over the past 20 years. The status of the industry remains intact, although the global environment has turned challenging," Chirag Kachhadiya, lead IT analyst at Ashika Stock Broking Ltd, told Mint.
“That said, we should look beyond the headlines and see how and when these deal wins translate to revenue growth. Most companies are witnessing flat-to-negative revenue growth due to client caution and a tough operational environment," he added.
Operational metrics: Reduced subcontracting costs, increased efficiency and better utilization gave a fillip to companies’ margins, though wage hikes and travel costs capped the gains.
TCS posted an earnings before interest and taxes (EBIT) margin of 26%—the highest in the last 12 quarters and within the firm’s aspirational band of 26-28%.
Mid-cap IT players too posted some encouraging numbers. Persistent Systems logged a healthy revenue growth of 13%, while Cyient saw deal wins from marquee clients like Airbus and Deutsche Bank.
“Mid-cap IT companies are witnessing increased chances to compete for larger deals. Although verticals like banking and financial services (BFSI) and high-tech are currently facing challenges, there is significant demand in healthcare, life sciences, manufacturing, and engineering research and development (ER&D), areas where the tier-II companies can excel," Anil Rego, chief executive officer (CEO) and founder of investment advisory and wealth management firm Right Horizons, told Mint.
AI boost: The prevailing sentiment some quarters back was that Indian IT firms have been caught unawares by the sudden emergence of GenAI. Some doomsayers even predicted the end of the software outsourcing industry altogether. However, an ounce of execution trumps tonnes of hyperbole.
As the Q4 performance has demonstrated, Indian IT companies are going full throttle to reap the benefits of AI, which is also emerging as the top priority for clients.
IT firms have prominently highlighted their AI efforts during their post-result concalls.
TCS reported doubling of its GenAI pipeline to $900 million and noted that many AI deals have moved from proof of concept stage to larger, actual contracts. Pharma and life-sciences are some of the segments where TCS has garnered several AI-led projects. Infosys said it has generated over three million lines of code using one of the GenAI large language models in the public domain. HCL Tech CEO C. Vijayakumar asserted that global enterprise technology spend will only grow with adoption of AI.
“GenAI is witnessing massive investments with a promise of various cost-saving use cases across industries. We are in the camp that see GenAI as a huge opportunity rather than disruption. This is like a situation when cloud computing, blockchain, etc. were introduced. All such technological advancements have only led to larger opportunities for the Indian IT companies that excel in system integration," said Mohit Khanna, fund manager at Purnartha Investment Advisers, an investment advisory and portfolio management service firm.
The Bad
Western headwinds: The common thread running through the Q4 results was that the demand environment remains uncertain amid macroeconomic turbulence in the mainstay markets of US and Europe.
“Challenges such as economic slowdown, soft recession, high interest rates, geopolitical tensions continued to put pressure on the consumer business group vertical throughout 2023-24," TCS CEO K. Krithivasan said during the company’s earnings call. Revenue from North America, which accounts for around half of TCS’s topline, slipped 2.3% in the fourth quarter, while that for Infosys dropped 2.1%. The trend was seen in most other IT players as well. Wipro’s management commentary around discretionary spend was akin to peers and “indicates continued caution in the demand environment. In the absence of discretionary spend, deal conversion to revenue has been poor in the past couple of quarters. Hence, healthy deal wins fall short to support strong growth visibility," ICICI Securities said in a note.
Tech Mahindra’s Q4 net profit plunged 41% on-year to ₹661 crore, weighed by tepid demand in its key verticals telecom, communications and media. Its full-year profits plunged 52%—its steepest decline on record.
“Q4 marks the low point in our year-on-year growth trajectory," the firm’s CEO and MD Mohit Joshi said, adding that there will be improvement from the next quarter.
BFSI downtrend: Just like North America is the most important geography for domestic IT firms, BFSI is the biggest vertical for most companies, accounting for around a third of the topline. When the BFSI vertical wobbles, it sends alarm bells ringing throughout IT services firms.
During Q4, TCS saw BFSI revenue drop 3.2% on-year, while that of Infosys tumbled 7.1%. Wipro posted a nearly 9% fall.
At its post-earnings concall, the Infosys management highlighted that the macroeconomic effects of stubborn inflation and higher interest rates are leading to cautious spending, even as clients are actively looking to move workload to cloud.
The Ugly
Headcount hit: As the original sunrise sector of post-liberalization India, the IT industry has been the crowning jewel of the domestic economy for decades.
A job in the IT sector has been, often literally, the passport to a better life for millions of young graduates and professionals. Any slowdown in hiring in this crucial sector, therefore, should serve as a red flag for policymakers.
2023-24 was the first time in 20 years that the three leading IT organizations—TCS, Infosys, and Wipro—reported a cumulative headcount decline, that too by a massive 64,000. In the March quarter alone, the three firms together saw their headcount shrink by over 13,000.
However, HCL Technologies bucked the trend by adding 2,725 employees in the quarter. But with the sector grappling with demand uncertainties and other challenges, the hiring model is seeing some serious adjustments.
“We no longer hire all the freshers from campus. We hire less than half of them from campus and the rest we hire off campuses. So, we have that agile model. We will look at hiring as the year goes through. We do not have a number to give at this point in time," Infosys’ chief financial officer Jayesh Sanghrajka said at its earnings call.
Not just that, experts say that with the rise of AI, machine learning and other new-age technologies, a lot of IT roles in areas like testing, routine coding and maintenance are at the risk of being automated.
Specific stings: Not just sectoral headwinds, investors also had to deal with a couple of company-specific issues. Infosys reported a sequential revenue decline of 2.2% (on constant currency basis) at $4.56 billion in Q4. This was partially driven by a one-off hit from re-scoping part of the work the company does for a large BFSI client. As a result, its 2023-24 revenue growth stood at a measly 1.4%—the lowest in the company’s over 40-year history.
Despite recording the highest-ever deal total contract value of $17.6 billion during the year, the company has given out a muted revenue guidance for 2024-25, disappointing analysts.
“Amid persistent weakness in discretionary spending due to caution on macro recovery, Infosys provided an underwhelming USD CC revenue growth guidance of 1%-3% year-on-year (y-o-y) for 2024-25, significantly below our estimates," domestic brokerage house Motilal Oswal said in a note.
Another company which disappointed the Street was Wipro. The sudden resignation of the company’s CEO and managing director Thierry Delaporte, barely two weeks before the Q4 results announcement, had spooked investors and laid bare the leadership tumult and cultural clashes hobbling the firm’s turnaround efforts for a long time now.
True to investors’ fears, the company delivered a grim performance. Its Q4 revenue declined 6.4% on-year to $2.6 billion, while deal wins dropped 14% to $3.6 billion. Barring health, all verticals saw a y-o-y drop in topline. Revenue on a constant currency basis fell for the fifth straight quarter. The management’s revenue growth guidance for the first quarter of 2024-25 of (-)1.5% to +0.5% further dampened sentiment.
The Road Ahead
Multi-billion-dollar deal wins and cutting-edge AI projects might provide investors a much-needed shot of optimism, but the writing on the wall is clear—the IT pack has run into a maelstrom of challenges.
The Indian IT services sector is staring at a second consecutive year of muted revenue growth due to modest increase in tech spends in Europe and the US, Crisil Ratings said on 24 April. The rating agency expects the sector to grow at 5-7% this year, after a growth of 6% in 2023-24.
The global macro signals too remain lacklustre.
US gross domestic product (GDP) increased at a 1.6% annualized rate in January-March 2024—the slowest pace in two years as consumer and government spending cooled amid a sharp pickup in inflation.
Inflation, in turn, is delaying the much-awaited rate cut from the US Federal Reserve. Global markets, which last year were confident of four rate cuts in 2024, have now scaled back their expectations to three, at best.
Meanwhile in the domestic equity market, ‘smart money’ has made its preference clear.
The IT sector witnessed the highest selling by foreign portfolio investors (FPIs) during 1 April-15 April at ₹4,658 crore, according to data from the National Securities Depository Ltd (NSDL). This came after FPIs offloaded IT shares worth ₹1,659 crore in March.
FPIs had sold IT stocks worth ₹7,066 crore in 2023, the second highest sectoral outflow for the year after oil and gas.
Which raises the question: with the entire sector engulfed in gloom, isn’t this the most opportune time to buy IT stocks?
“No one can predict the exact bottom, but I would say we are somewhere near it, perhaps it’s one to three quarters away. In this context, if you are a long-term investor, I recommend looking at large-cap IT, particularly TCS and Infosys due to their robust deal pipeline and top-class quality of management," Chirag Kachhadiya of Ashika Stock Broking said.
“In the mid-cap space, one can look at Persistent on the back of its target to double its turnover to $2 billion in the next three years. That said, investors would do well to temper their return expectations in the near-term," he added.
