Tech spending crunch could hit Indian IT sector in Q1

As TCS prepares to announce its first quarter results for June 2022 quarter on 08th July, The big question is once again on the outlook for earnings growth, top line growth and operating margins. Let me caution here that TCS does not provide forward looking guidance and restricts itself to a detailed review of business. However, one concerns is that the operating margins in the June quarter for TCS and the other major IT companies would have mostly compressed on a yoy basis as well as on a QOQ sequential basis.

 
Of course, while TCS does not provide guidance, the other large IT companies like Infosys, Wipro, HCL Tech do provide adequate guidance on future performance. The concern is that with the supply-side challenges yet to settle down, margins for most of the IT players will be under pressure. This is largely on account of higher retention costs and higher travel costs. Infosys would be the last among the big IT companies to announce results on 24th July but the pressure of weakening IT spending and higher costs is likely to manifest in Q1 numbers.

Prima facies, the analysts still remain optimistic as do the managements of IT companies. The broad expectation is that for top-tier and mid-cap IT services companies, demand is likely to have remained robust, largely on the back of cloud and digital transformation. However the June 2022 quarter is likely to show signals of shifting demand for the worse. While tech spending is not likely to show overall strain, specific sectors like real estate, retail and manufacturing are expected to tone down the pace of tech spending in the quarter.

Most analysts believe that it is still early for the Cassandras to come calling. Hence, nobody is really looking to downsize their forecast. However, such pressures may become more pronounced in the second half of the year. This would be largely on account of elevated inflation levels as well as an economic slowdown in both the US and Europe. These are two of the largest markets for IT service. The markets are likely to become a lot more discerning and selective on which IT stocks to upgrade and which to downgrade.

One thing that cannot be wished away is the margin pressures over the next two quarters. Broadly, the supply side impact will still be there. In fact, the latest numbers of Accenture amply demonstrate that the all-important rate of attrition is on an upward trajectory across most of the large and mid-sized IT companies. This is likely to compress the EBIT margins by as much as 400 basis points. The biggest pressure points for the IT sector will come from higher travel cost, and a decline in utilisation levels as companies hire more freshers.

One more thing the global slowdown and recessionary conditions will create is stickiness in pricing. For example, retention costs have gone up substantially for Indian IT companies. Price hikes are going to get a lot tougher in the recessionary situation globally. In fact, IT companies will be happy with stable pricing since that would be equally important in the absence of price increases. The focus of Indian companies will be on protecting their client margins at the very best.

If you look at the top five IT companies viz. TCS, Infosys, HCL Tech, Wipro and Tech Mahindra, two common trends are visible .Firstly, the operating margins on a yoy basis are likely to be lower by around 150-300 basis points and could vary on a case by case basis. At the same time, even on a sequential basis, the margins are likely to compress around 100 bps on an average. The pressure on margins is going to be tough to escape for the Indian IT companies. The challenge may have just about begun.