IT companies' margins decline to decade-low of 23.2% in June quarter

Wipro, Tech Mahindra see double-digit decline in net profit

After a big jump in the margins and profits in the quarters immediately after the break-out of the Covid-19 pandemic in March 2020, the export-driven IT services companies are now facing their biggest earnings challenge in more than a decade. The operating or EBITDA (earnings before interest, tax, depreciation and amortisation) margin of the industry declined to more than a decade low of 23.2 per cent in the first quarter of the 2022-23 financial year (Q1FY23) as operating expenses raced ahead of revenue growth or the firms.

The industry operating margins had reached a seven-year high of 28.8 per cent of the total income or revenues during Q3FY21. Margins have been on a downhill since, despite double-digit growth in revenues. The pace of margin contraction seems to have accelerated in the recent quarters.

The industry's average operating margins was down 360 basis points on the year-on-year (YoY) basis in the first quarter while it was down 190 basis points quarter-on-quarter (QoQ).

The combined operating profit of the country's top-17 listed IT companies was up 3 per cent YoY to Rs 37,416 crore in Q1FY23. This was the lowest growth in the industry's operating profit in the last 18 quarters. For comparison, the combined operating profit was up 21.5 per cent YoY in Q1FY22 and 9.8 per cent YoY in Q4FY22.

The combined net profit for the 17 firms, including Tata Consultancy Services, Infosys, Wipro, HCL Tech and Tech Mahindra was up just 0.1 per cent YoY to Rs 23,696 crore in Q1FY23, the slowest growth in earnings in the last five-years. The combined earnings were down 8.3 per cent QoQ in the first quarter.

Among individual companies, Wipro was the biggest laggard among the top companies with 21 per cent YoY decline in net profit in Q1FY23, followed by Tech Mahindra with 16.4 per cent. Oracle Financial Services saw 6.2 per cent decline while TCS, Infosys and HCL Tech managed to report low single growth earnings in Q1FY23.

Analysts attribute margin decline and poor earnings growth to a faster rise in operating expenses, especially the employee cost. "The operating expenses for the industry is now growing much faster than underlying growth in revenue, leading to margins contraction. The biggest culprit is salary and wage growth that has shot-up for all companies due to a sharp rise in attrition rate in recent quarters," says G Chhokkalingam, founder & MD Equinomics Research & Advisory Services. He expects margins to remain under pressure until companies manage to bring down their attrition rate to a more manageable level. This, he says, will take at least a few quarters more.

The industry's operating expenses, including salary & wages and operating overheads, were up 24.9 per cent YoY in Q1FY23, outpacing the net sales that were up 19.7 per cent YoY in the same quarter. For the quarter, companies’ combined salary & wages bill was up 21.1 per cent while other expenses, including sales & marketing expenses and operating overheads, were up 35.2 per cent YoY.

Some analysts also link the higher employee cost to wage inflation in the United States as the reason as the other reason for the slowdown. “IT is a global industry and its growth and margins are greatly influenced by global economic changes. The US is facing wage inflation that has pushed-up the salary and wage bill for tech companies all over the world,” says another analyst on the condition of anonymity.

Analysts expect industry margins to start improving in FY24 as the US central bank manages to bring down wage inflation in their economy and employee attrition falls in India.