Weak quarter projected for IT sector; recession in US, Europe may affect FY24

The IT sector is projected to report a weak quarter, affected by Quarter 3 (October-December) seasonality and worsening macroeconomic conditions. The factors of economic volatility are causing growth to moderate towards pre-COVID levels, even as long-term drivers remain stable.

Analysts tracking the IT sector believe that recessionary trends in the US and European markets could affect FY24 (April-March, 2024), which could lead to a big drop in attrition rates. IT services companies had strong growth last year because of high demand and fewer layoffs. However, this year’s third quarter (October–December) could be slow because some clients have put off spending, and inflation is high.

“We expect tier-I IT companies (TCS, Infosys, Wipro, etc.) to have 0.6 per cent to 3.1 per cent QoQ (quarter-on-quarter) CC (constant currency: fixed exchange rate) revenue growth, 60bps (basis points) QoQ (quarter-on-quarter) margin expansion, and a 5 per cent QoQ PAT (net profit) increase in a seasonally slow quarter where furloughs will have a bigger effect,” said Apurva Prasad, Amit Chandra, and Vinesh Vala, research analysts at HDFC Securities.

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“We have assumed that revenue growth will slow from 13.5 per cent CC in FY23E (estimate) to 8.5 per cent in FY24E and FY25E,” they added.

Profit may improve

At the same time, the profit trend is likely to improve in FY24E (compared to FY23E) as the supply side crunch eases and demand moderates. The worry is clear from the fact that onsite tech job postings have gone down by 10 to 20 per cent in the past two months and that macro indicators are slowing down, even though the key drivers of digital seem stable.

Analysts at ICICI Direct said the US market is likely to be affected by high inflationary pressures, while the Europe market is likely to be affected by energy shortages that will affect the manufacturing sector. In their note to investors, Sameer Pardikar and Sujay Chavan said some companies have already shown pain in a few areas of banking, financial services (mortgages), retail, high technology, and telecommunications. This pain is likely to continue in this quarter as well, said research analysts Pardikar and Chavan.

Accenture’s recent numbers for its outsourcing business were good. It reported that bookings for outsourcing grew 9.7 per cent from the same time last year to the same time this year. “We note that the numbers may look lower from one quarter to the next, but the historical trend shows that new order bookings are generally lower in Q1 than in Q4. This is because 20 per cent of the year’s new bookings happen in Q1, and new bookings gradually increase in the following quarters,” the research analysts said.

Also read: TCS profit up, but IT sector staring at tough export markets, rising attrition

“Assuming similar growth in new order bookings in Calendar Year (CY) 23, our back-of-the-envelope calculation shows that outsourcing bookings for CY23 are likely to be in the range of US$40.5–41 billion, which is a strong 19 per cent growth or more and is likely to lead to strong high-teen growth in outsourcing revenues for CY23,” they added.

The note said companies with end-to-end capabilities, stable management, and better execution track record, especially in large deals, are likely to be winners. “We expect Infosys to stick to its 15 per cent–16 per cent constant currency (fixed exchange rate) revenue guidance for FY23E since the growth rate for H2 is not difficult to achieve. Even in Q4, we think the company will stick to the same plan for guidance. We also don’t think that the company will change its margin guidance of 21 per cent to 22 per cent because it has already taken into account rising costs. Revenue growth is expected to be 1.5 per cent for TCS, 1 per cent for Infosys, and 1 per cent for Wipro, in that order,” it read.

Weak spots

LTIMindtree, one of the tier-II IT companies, is expected to report its first consolidated results since Mindtree and LTI merged. In constant currency (CC) terms, the merged entity is expected to grow by 3 per cent from quarter to quarter.

Motilal Oswal predicts that IT services will have a median revenue growth of 1.9 per cent QoQ and 9.1 per cent YoY in terms of constant currency (CC) in 3QFY23E. At the beginning of the quarter, it was thought that the weakening macros and fears of a recession would hurt the overall demand environment more than they did. But research analysts Mukul Garg, Pritesh Thakkar, and Raj Prakash Bhanushali said there are still some weak spots in the consumer-facing verticals, where decisions have been put off and spending on non-essentials have been cut.

Also read: How Indian IT sector has moved from strength to strength

“Our recent talks with the management of tier-I companies (except for Wipro and Tech M) showed that there will be a limited negative effect on demand, but there will be softness in certain verticals (mortgage, retail, telecom, and hi-tech), as well as in certain geographies” (Europe). People had different things to say about Europe. For example, Infosys and Tech Mahindra are seeing signs of slowing IT spending as clients become more cautious.