Q1FY23 results: Margin pressure on IT services to remain, focus on outlook

Amid concerns of a likely recession in the US and Europe and rising inflation worldwide, the first-quarter results of FY23 in the Indian IT services industry will be keenly watched for management commentary on the demand outlook. With supply-side challenges yet to settle down, margins will be under pressure due to higher retention costs, and travel. However, the silver lining could be a falling rupee.

Indian IT services results will start coming in from July 8, with Tata Consultancy Services (TCS) being the first company to announce its numbers. Infosys will be the last among the top four companies to share its results on July 24.

Analysts tracking the sector said in their current commentaries, company managements of both top-tier and mid-cap IT services firms have reiterated the robust demand environment due to cloud and digital transformation. However, many analysts now believe that the first signs of any shift in demand will be evident in Q1 FY23.

“While our recent discussions with management indicate continued momentum in spending on technology services, we expect initial signs of an impact in sectors like retail and manufacturing in Q1 FY23,” said an IT preview report from Mukul Garg and Raj Prakash Bhanushali of Motilal Oswal.

Analysts are not expecting companies to change their guidance forecast yet, but the second half of FY23 and FY24 will have an impact. “While the long-term demand environment remains unaltered, we anticipate an impact in H2FY23 and FY24 due to elevated inflation and an economic slowdown in both the US and Europe. We are trimming our FY23/FY24 INR EPS by 2-5 per cent, despite a positive 300-400 bp impact from a lower INR (79/USD),” said the Motilal Oswal report.

Infosys is expected to lead the growth charts among the top-tier lot, followed by TCS. Seasonal weakness and company-specific issues will impact HCL Technologies, Wipro and Tech Mahindra. Among the mid-cap players, Mindtree and Persistent will continue to lead growth, said reports.

While the focus will be on the growth outlook, margins are expected to continue to be under pressure for the next two quarters before they start to normalise. Supply-side issues continue to impact companies. The recent Accenture results also showcased that attrition is on an upward trajectory.

“Companies are incurring high talent retention costs (retention bonus, out-of-cycle wage revision etc.). The challenge exists, in India as well as onsite. This pressure will seep into margins; we forecast a 70-400 bp YoY decline in Ebit margin across our coverage universe,” said Kawaljeet Saluja and Sathishkumar S of Kotak Institutional Equity Research.

They elaborate that headwinds on margins are in the form of wage revision for Infosys and TCS and Tech Mahindra, added travel cost, and a decline in utilisation as companies hire more freshers.

One other area of focus will be pricing. With supply-side concerns still ongoing, the companies' retention costs have gone up substantially. Those who have been waiting to get a price hike may have an uphill task with global recessionary issues. “Securing price increase in the second half could become challenging. For now, a more reasonable assumption will be stable pricing rather than a view of pricing increase,” said the Kotak report.

If one has to take cues from Accenture, which recently announced its Q3 results, then demand is robust but some of the management comments did hint toward focusing on growth and cost optimization.

What to watch for:

• Management commentary on demand
• Hiring momentum, a good sign of demand
• Attrition trend
• Deal momentum or TCV signed