Amid the risk of a slowdown, these IT companies are best placed to survive the storm

• Concerns about delays and cost reduction mandates from customers emerged in comments from Indian IT companies in the second quarter.
• While India’s top IT companies have shown improvement in operating margins, analysts suggest two companies are best placed to survive a slowdown.
• Hiring delays, employee turnover and deal pipelines are key metrics to watch out for, according to analysts.

The cycle of rate hikes unleashed by central banks around the world has increased the risks of a global recession. This has also been a concern for most Indian IT services majors as they get most of their business from North America and Europe. Analysts have been signaling a potential slowdown in earnings for some time, even as they battle rising wage costs at home.

While many Indian IT companies reported improving operating margins during the September quarter, management commentary also focused on concerns about the slowdown. According to a report by Kotak Institutional Equities, two companies are best placed to face the risk of a slowdown in the US and Europe, the largest markets of Indian IT majors.

“Infosys will lead growth and gain market share, even in a slowdown, given its improved cost recovery capabilities. HCL Tech has delivered robust growth trends in the services sector and improved margins,” the report said.

For context, Infosys reported $2.7 billion in big deal profits in the second quarter — its best performance in the past seven quarters. On the other hand, HCL Tech closed a mega deal worth $625 million.

Both Infosys and HCL Tech also reported stronger-than-expected operating margins during the quarter, making them the top-performing companies in the top four IT companies.

“Despite a higher likelihood of a recession in key European countries and an energy crisis, sales growth in Europe at constant exchange rates remains strong,” the report said on the IT sector’s Q2 performance.

Operating margins came under pressure in the first quarter due to wage increases, higher outsourcing costs and backfill costs. In the second quarter, it improved in the range of 15-150 basis points for Tier 1 companies.

“A healthy margin expansion from the lows of Q1 FY23 will allay investor concerns,” the report said, while pointing out that there is still more room to improve margins and will happen in the coming quarters.

Slowdown baked into stock prices – recession, not quite

The broader Nifty IT index has so far corrected 25.6% in 2022. Apart from Wipro, top IT companies such as TCS, Infosys and HCL Tech have managed to outperform the Nifty IT index during this period.

Source: NSE, as of November 1, 2022, 1.30 p.m.

“The second half of FY23, unlike in recent years, will be affected by leave and seasonal weakness. Equities have entered a slowdown, but not a recession,” the report said.

Cautious optimism

“Our vision is that in this macro environment we are ready for all types of customer work. Whether it’s focused on digital and growth, or on cost,” said Salil Parekh, CEO and MD of Infosys during the September quarterly results, noting that there are indeed demand issues in the otherwise resilient telecom sector.

Despite these concerns, Parekh sounded cautiously optimistic, with Infosys adjusting its revenue forecast to 15-16% for FY23, up from 13-15% given at the start of this fiscal year.

HCL Tech was also able to deliver stronger than expected results due to higher realisations. This, along with closing the deal in the first half of FY23, gave the company the confidence to raise its FY23 revenue forecast by 50-150 basis points to 13.5-14.5% in constant exchange rates.

The report underlines that mega-deal activity has been muted, with only HCL Tech reporting a single $625 million mega-deal.

“We expect significant significant cost reductions in H2 FY23 and FY24. Such deals could cushion the impact of the slowdown in global IT spending in FY24,” the report said.

Key metrics to watch out for: hiring delays, churn, and deal pipeline

Hiring delays, deal pipeline and churn are the key metrics to watch out for, according to the report.

Overall, IT majors reduced headcount by 57% in the second quarter, with Wipro reporting the most significant reduction at 95%, followed by market leader TCS at 58%.

Attrition also remained high, with Infosys reporting the worst numbers at 27.1%, followed by HCL Tech at 23.8%.

The report also notes that while the deal pipeline remains robust for all businesses, in some cases the closing of deals was impacted by delays in decision-making.

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