IT costs avoid the challenge of profit degradation

NEW DELHI : Most information technology (IT) services majors have continued to show resilience in the current environment, although macroeconomic headwinds were expected to remain strong. The September quarter performance of Infosys Ltd, Tata Consultancy Services Ltd (TCS) and HCL Technologies Ltd exceeded most analysts’ expectations.

Consistent currency growth remained strong, although the impact of currency headwinds continued. Deal wins and order flow remained healthy, improving business prospects in the second half of FY23 amid recession fears.

“So far, the IT sector has gotten off to a good start this quarterly season, with TCS, Infosys and HCL reporting results much better than Street’s estimates. All reported strong margin expansion, with solid growth in revenue,” said Aishvarya Dadheech, fund manager, Ambit Asset Management. Mid-cap companies like Mindtree and Cyient also reported much better numbers, Dadheech added.

Mitigating operational challenges and recovering margins remained key, which helped improve sentiment more than revenue growth, analysts said. Supply issues are being resolved.

The improvement in most companies’ margins in Q2 is attributed to cost optimization, currency depreciation and the normalization of outsourcing costs.

High attrition, which remains a major concern for investors, is showing signs of easing. With supply-side pressures easing, the average attrition reversal is visible in Q1-Q2 FY23, which will be a huge contributor to margin expansion in the coming quarters, a said Dadheech.

Analysts said the improvement in the attrition rate will be more visible in the future. The cost of replacements has also gone down. In fact, more employee additions by companies such as Infosys remain encouraging and add to the positive outlook, said Apurva Prasad, Institutional Research Analyst, HDFC Securities Ltd.

Overall, the orders won improved the outlook for the second half, where macroeconomic challenges are expected to have the most impact, analysts said. The factors that led to the earnings downgrade of late are also improving as pressure on margins eases, Prasad said. It is positive and may also help sectors achieve better valuation multiples over the next few days.

“The element of surprise was that HCL and Infosys raised their FY23 revenue guidance. This reflects optimism on growth despite concerns over potential fallout from the economic slowdown in the US and Europe. said Dr. VK Vijayakumar, Chief Investment Strategist, Geojit Financial Services. “Overall, the IT majors’ second quarter results were better than street expectations on most metrics.”

Currency headwinds continued to have an impact, however. While the stronger dollar is positive for the sector, the weakening of European currencies such as the euro and the pound minimizes the benefits, at least partially, analysts say.

Currency tailwinds are provided by a stronger dollar despite weakening other currencies. Tailwinds in currencies provided a positive friction of 80 basis points, said Omkar Tanksale, senior research analyst at Axis Securities. More than 40% of industry revenues are denominated in dollars. However, the lower attrition rate remains a bigger advantage, Tanksale said, as labor costs contribute about 65% of costs.

Other positives, according to Tanksale, are that demand remains strong and even European regions have performed well. This speaks to the strength of the business structure of IT services companies, he added.

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