Shares of most IT services companies, including India’s top five Infosys, Wipro, Tata Consultancy Services (TCS), Tech Mahindra and HCL Technologies, traded in the red on Monday. The downward trend comes alongside unrest in the technology sector, where many companies are opting for mass layoffs to stave off fears of a recession.
“While technology adoption continues to grow across industries, we expect a slowdown over the next 12 months compared to the previous two years of strong spending… Our 2014 revenue estimates are lower than consensus numbers,” brokerage Nomura said in its latest report.
Nomura’s report comes after it refreshed its database of 1,000 relevant G2000 companies and found that the earnings growth outlook for these companies in calendar 2023 (based on the Bloomberg consensus) has continued to deteriorate since September 2022.
“Technology budgets are tied to corporate revenue growth, indicating a further slowdown in demand in the coming quarters.” In particular, the BFSI, manufacturing and technology verticals have seen the biggest decline in the last three months,” the statement said.
The brokerage explained that for Indian IT services companies, the pain is likely to be more pronounced in interest rate-sensitive sectors such as mortgage, capital markets in the BFSI vertical, discretionary retail and pockets of manufacturing verticals.
Kotak Securities pointed out that BFSI makes a significant contribution to the overall revenue of Indian IT services companies. It noted that Mphasis earned 54 percent of its revenue from BFS, Wipro earned 35.4 percent, LTI earned 34.2 percent while Infosys earned 30.5 percent of its revenue from BFSI in the July-September quarter of the fiscal.
“BFS companies continue to talk about technology investments, but remain cautious on macro.” Modernization of technology is a key priority and is considered necessary and strategic. Companies have increased investments in technology based on expectations of healthy return on investment (ROI) in the medium term,” Sumit Pokharna, vice-president, fundamental research, Kotak Securities told CNBCTV18.com.
In the near term, according to Nomura, layoffs are likely to affect the sector’s growth in the third quarter of fiscal 2022-2023. “Overall, we expect USD revenue growth to decelerate from 12.7 percent in FY23 to 8.0 percent in FY24F for our coverage universe,” it said.
Nomura said deal advisers suggested a likely impact of a macro slowdown and continued high inflation in developed markets on the technology budget outlook for most industries in 2023.
While cost pressures and changing customer preferences continue to increase technology intensity in enterprise businesses and may lead to more business for Indian IT services in the medium term, IT budgets are likely to prioritize the areas of automation and cost efficiency in the near term, it said.
“Alleviating supply-side issues, such as mitigating attrition, is likely to reduce staffing costs.” Improving utilization, as recently hired employees are trained and deployed, would be another tailwind,” it said.
Meanwhile, Kotak Securities is bullish on tech investments due to expectations that the slowdown/recession will be viable, indicators such as credit quality, credit growth and consumer spending remain fairly robust and boost NII due to higher interest rates. “The optimistic view may change with the negative impact of macros on revenues,” Pokharna said.
According to him, overall industry growth in BFS technology spending will decrease in FY2024, and divergent performance across IT companies will be seen as it is impacted by 1) exposure to cost-cutting clients, 2) supplier consolidation decisions, 3 ) key client engagements and 4) large/mega deals.
“We have seen that insurance trends are increasing, and more and more banks are joining the fray. We are bullish on Infosys and HCL Tech and they are our top picks,” he said.