Revenue growth and margins for Indian IT services companies likely to moderate in the near term: ICRA

Revenue growth for the sample set to moderate to 12-14% in FY2023 due to base effect, macro-economic conditions and inflationary headwinds across key markets.

ICRA maintains its Stable outlook for the Indian IT services industry supported by strong order book and healthy demand outlook, especially for digital services, whilst projecting a moderation in the revenue growth and operating profit margins (OPM) for its sample set of 13 major listed companies.

Commenting on near term expectations on industry performance, Deepak Jotwani, Assistant Vice President & Sector Head, ICRA,  says, “While the growth momentum for the IT services companies (ICRA’s sample set) largely sustained in Q1 FY2023, partly supported by INR depreciation against the USD, YoY growth is expected to moderate to 12-14% in FY2023 due to the base effect, macro-economic conditions and inflationary headwinds across key markets, impacting investments in technology by clients. Moreover, training and incubation costs for fresh hires recruited over recent quarters and salary hikes to retain existing talent will continue to result in wage cost inflation, leading to likely moderation in OPM by 100-150 basis points in FY2023. Notwithstanding the same, OPM is expected to remain healthy at ~22%. Further, the surge in attrition levels witnessed in recent times is likely to start tapering only by the end of FY2023. Consequently, OPM will improve over the medium term supported by stabilisation of wage costs with some optimisation of the employee pyramid, better realisation and employee utilisation.”

The IT services companies remain focused on enhancing the share of fixed price contracts as it assures better revenue visibility and also allows for higher deployment of offshore resources where the salaries are considerably lower coupled with better utilisation of manpower across such projects and deployment of automation. The benefits are shared with the client, leading to mutual advantage.

Given that the industry generates a sizeable part of its revenues in foreign currency, INR’s movement against currencies of key markets has a key bearing on the industry’s earnings. INR depreciation against the USD over the recent months is likely to bode well for the industry in FY2023. However, overall impact of foreign exchange fluctuations on the industry’s performance is also contingent on movement of INR vis-à-vis other key currencies, mainly GBP and Euro, over the near term, as INR has appreciated against both over the past quarter, which mitigates the gains on INR depreciation against the USD to some extent. Further, the overall impact will also depend on the extent of hedging by the companies. Most companies in ICRA's sample set usually hedge a large part of their forex exposure.

“ICRA maintains its Stable outlook for the Indian IT services industry supported by strong order book and healthy demand outlook, especially for digital services. Moreover, credit profile of Indian IT services companies remains comfortable supported by healthy internal accrual generation and strong balance sheets. Notwithstanding steady outflow towards rewarding shareholders and investments to fuel inorganic growth, the liquidity position of ICRA sample set is expected to remain strong aided by healthy internal accrual generation and availability of surplus cash and liquid investments.” Jotwani added.

Indian IT services companies reported healthy revenue growth in FY2022 (17.6% YoY in INR terms for ICRA sample set) driven by accelerated demand for digital technologies (especially for services such as cloud computing, cyber-security, artificial intelligence, among others) and partly due to the low base of FY2021, which was impacted by the Covid-19 pandemic. The growth was broad based across all key verticals of BFSI, telecom, manufacturing, retail and distribution. Revenues for the sample set in key markets of the US, Europe and rest of the world (RoW) grew by around 17.7%, 21.0% and 14.5%, respectively, on a YoY basis in FY2022. However, growth in Europe has tapered over the past two quarters, owing to some moderation in order inflows because of the ongoing geo-political issues.

The aggregate operating profit margin (OPM) for the sample set declined to 23.3% in FY2022 (as against 24.2% in FY2021) owing to considerable increase in employee costs, as the industry grappled with surge in attrition levels due to demand-supply gaps. To combat the same, IT services companies have offered healthy wage increments and incentives, significantly shored up hiring activity, offered extensive working arrangement flexibility and reskilled their employees, all leading to increasing costs. The industry reported a record level hiring in FY2022, with the top five leading domestic IT services companies accounting for ~75% of the same.