Indian IT services companies are likely to start the new year on a strong footing. Despite being a traditionally weak quarter due to furlough, domestic IT firms are expected to post strong third-quarter results. If Accenture’s results are the indicators to go by, the demand environment remains strong globally with pandemic-led digital transformation driving the IT spending.
Though margins are likely to be under pressure, a fall in rupee value against the US dollar will provide a cushion. Similarly, there are early signs of falling attrition levels, which have emerged as the key risk area in recent quarters. However, market watchers will look forward to the management commentary on the deal pipeline and the impact of the Omicron variant on the demand environment along with plans of resuming work from offices to get clarity on what the future holds.
“As seen in Accenture results, demand is definitely there. This demand uptick is also observed in all verticals, service lines, and geographies. So, it is a broad-based demand environment. That way, the Q3 results of IT firms should be good. Also, attrition should come down. Margin should get a breather from rupee fall. Except for the furlough issue, there are no major concerns,” said Pareekh Jain, an IT outsourcing advisor & Founder of Pareekh Consulting.
“However, mega deals have not been announced by the companies in the third quarter. So, commentary on the mega deals and overall deal pipeline will be crucial. Moreover, clients decide their IT budgets for the next year during this period. So, some indications on budgets and pricing will come from management,” he added.
Accenture, which follows the September-August financial year cycle, has posted stellar first-quarter results this month. On the back of robust demand, the global IT giant has revised its full-year revenue guidance to 19-22% from 12 to 15% forecast earlier. Similarly, new bookings were at a record $16.8 billion in the first quarter, a 30% increase over the same period last year. Significantly, consulting bookings of $9.4 billion, reflecting rising traction.
“Accenture’s blockbuster performance and solid commentary support our thesis of a robust tech upcycle that would continue for four-five years,” brokerage firm Edelweiss said in a report.
Against this backdrop, large IT services firms will be comfortably placed to achieve double-digit revenue growth this fiscal. Analysts also said that as the demand environment is broad-based, mid-tier firms will also continue their stellar run with some posting revenue growth rate in high teens.
Margin defence, fall in attrition likely
During the third quarter, some easing of supply-side issues like high attrition levels is likely. Early indications of this new trend are already visible. The Naukri JobSpeak index - one of the benchmarks that gauge the hiring activity for different sectors - has shown a fall in hiring activity for October and November 2021 in the IT sector. Similarly, Accenture’s attrition has shown a downward trend in the first quarter. Its attrition fell by 200 basis points to 17% on a sequential basis as compared to 19% in the previous quarter. A record number of hiring over the previous quarters along with the mass entry of freshers are likely to ease the supply-side constraints of IT companies in the third quarter.
On the margin aspect, IT firms are likely to defend the margins during Q3 of FY22 as seen in the previous quarter. Though resumption in travel to some extent and work from offices for a higher number of employees are certainly going to push the SG&A (Sales, General & Administrative expenses) in Q3, fall in rupee and pricing revision are likely to lend some support on the operating margin front.
Emkay Financial Services in a recent note has said that clients are more willing to price revisions that will support margins. “The demand environment remains good. We are able to get a price increase. That’s an ongoing process,” Amit Chadha, CEO & MD of L&T Technology Services told DH in a recent interview.
Orderbook, Omicron impact crucial
Despite many positives, the spread of the Omicron variant in recent months has created a level of uncertainty in the business world. And global IT industry is no exception. Industry watchers will be keen to understand the demand trajectory going ahead on the back of rising infections.
“Enterprises finalise their IT budgets during the last quarter of every year. It will be interesting to hear the management commentary on overall demand outlook which will give some indications on FY23 growth rates,” said Jain.
Moreover, companies may give some clarity on resuming work from offices which seems to be put on hold owing to the spread of new variant.
Orderbook is another indicator that will be keenly watched. In the third quarter so far, there are hardly any announcements on mega deals, which has emerged as the key factor in driving revenue growth this fiscal year.
Despite uncertainties, IT firms’ dream run is likely to continue in the third quarter. The only factor to watch out for is whether companies can sustain the momentum in FY23.
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