The top IT firms will announce their third-quarter earnings for the current fiscal next week, and there is much optimism around the numbers. Analysts will watch out for the managements’ commentary on the deal pipeline, especially large deals, and pricing, attrition trend and efforts to curb it, and margin outlook.
Over the previous two quarters, these companies, and the rest of their peers in the sector, had not made any major deal announcements like the ones that hit the headlines exactly 12 months ago.
In December 2020, Infosys won its largest-ever deal, bagging a $3.2 billion contract from Daimler, while Wipro won a $700 million deal from Metro AG. Wipro topped it up by buying London-based Capco for $1.45 billion.
For the fourth quarter of 2020-21, Wipro had won deals worth $1.4 billion while for the July-September quarter of 2021-22, Infosys had bagged 22 deals worth $2.6 billion. TCS, for the fourth quarter of 2020-21, won deals worth $9.2 billion.
However, since these big wins were spread over nine to 12 months, there has hardly been any major contracts coming their way, giving rise to concerns that a hybrid model of work may have allowed foreign multinationals at their home base to cut down on their cloud, cyber and security budgets.
Nevertheless, analysts believe that the sector will still have winners and for the third quarter, the demand outlook for all the IT companies is expected to remain robust.
Prabhudas Lilladhar, a research-based financial services organisation, in its note to investors pointed out that demand for compressed technology transformation with a focus on faster execution is resulting in high velocity of small and mid-sized transformation deals. Many of the transformation deals are broken down into smaller packets so as to reduce execution time.
“Therefore, absence of large deals or lower TCV (total contract value) number does not necessarily mean weak revenue growth. The deal pipeline continues to be at record high levels led by broad-based demand for digital, cloud, data analytics, 5G, IoT, cybersecurity and AI,” Aniket Pande and Aditi Patil said in their note.
The analysts expect that the IT majors will announce large deal wins with TCV expected to be in the range of $700-800 million.
“Amongst large caps, we forecast revenue growth in the range of 3-4.4% QoQ (quarter-on-quarter) in CC (constant currency) terms,” IDBI’s Devang Bhatt and Jayalaxmi Gupta said in their note to investors.
Prabhudas Lilladhar was quite optimistic as well, stating that even after five quarters of outperformance “we believe beat and raise cycle will continue led by sector’s entry in technology upcycle, digital becoming mainstream; strong order book and deal pipeline, accelerated demand for cloud adoption and broad-based demand across all industry verticals.”
“We expect strong sequential revenue growth despite Q3 being a seasonally weak quarter because of furloughs and lower working days. Growth is driven by high discretionary spends and compressed transformation initiatives across all sectors and markets,” Pande and Patil said in their note.
Three key areas of concern
Going forward, these are the three key areas of concern for the IT giants:
- Cutbacks in budgets for digital transformational and cloud projects
- High attrition rates
- Higher spends required to either retain talent or attract better talent
As far as the first issue is concerned, IT companies will have to remain relevant for their clients even when the budget cuts happen. They will need to have a longer-term focus and look beyond several quarters or even financial years. They will have to focus more on functionality whenever these cutbacks happen.
The next big area of concern is with regard to attrition levels. According to several estimates, the levels touched around 25% at their peak, which means that out of every 100 employees, at least 25 left the company for better salaries or better working conditions. To retain them, companies have been doling out huge incentives, raises almost every six months and even gifts like company cars.
Prabhudas Lilladhar said that due to the higher attrition levels, margins may be flattish or slightly lower on a QoQ basis.
“Margins will decline YoY as IT companies have rolled out wage hikes twice in the last year. Margin headwinds of backfilling of attrition with lateral recruits at higher costs and decline in utilization levels due to aggressive fresher hiring will be partially offset by pyramid optimisation, cost control measures and revenue growth leverage,” the note from Pande and Patil pointed out.
Tapering of attrition
A few analysts, however, said that attrition levels will actually drop over a period of time. While hiring will continue to remain high as companies try to fulfil demand, attrition will at one point in time, slow down.
“We see accelerated employee pyramid reshaping, which could control cost increases. We see WFH/WFA (work from anywhere) expanding the talent pool in a material way in the long term, especially through a greater number of over 30-year-old women remaining in the workforce and greater usage of gig worker platforms, reducing pressure on costs,” financial services firm Nirmal Bang said.
While IT companies will continue to earn more revenues over a period of time, their management will have to start preparing themselves for a cycle when the boom period starts slowing down, said analysts.