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Strong execution while attrition to watch out for in the Information Technology sector

ICICI Securities 13 Mins 09 Sep 2022

- Q1FY23 saw execution pick up for IT companies as it is a first full quarter of execution (barring company specific seasonality) after full/partial impact of furlough in Q3 and Q4. The demand environment continues to be strong, which reflects in healthy order book growth. However, companies did mention about weakness in a few pockets as far as tech spending is concerned due to some impact of macro headwinds. The weakness largely pertains to BFSI and retail verticals. It is also heartening to see no downward revision in revenue growth guidance in FY23 by any of the companies. On a reported basis, there was weakness in Europe region revenues, which can be largely explained by sharp GBP and Euro depreciation against US$ while CC growth remained stable there. Rupee depreciation against US$ help in strong revenue growth in rupee terms for the quarter. Tier I companies reported average constant currency growth of 18.1% YoY while Tier II companies posted CC growth at an average of 24.0% YoY. Operating margins were under pressure for both Tier I & Tier II companies due to implementation of wage hikes in few while increase in sub-contractor cost, uptick in travel related expenses & persistence of supply side challenges in others. Tier I companies reported margin swing of -150 to -200 bps QoQ. Tier II companies reported EBIT margin swing of +30 to -300 bps QoQ. LTM attrition remains elevated for most companies while hiring trend was a mixed bag 

- CC growth a mixed bag: TCS reported 1.3% QoQ, 10.2% YoY dollar revenue growth while in CC terms, it grew 3.5% QoQ, 15.5% YoY. The growth was driven by North America (53% of mix) growing 19.1% YoY in CC terms while vertical wise the growth was driven by BFSI, retail & healthcare reporting growth of 13.9%, 25.1% & 11.9% YoY in CC terms. Infosys’s revenues increased 5.5% QoQ, 21.4% YoY in CC terms while dollar revenues increased 3.8% QoQ & 17.5% YoY. Geography wise North America (62% of mix) led the growth with 4.5% QoQ growth while vertical wise it was driven by retail/communications/energy & manufacturing. Infosys increased its revenue growth guidance to 14-16% in CC terms for FY23 from earlier 13-15% due to the strong order pipeline. Wipro’s IT services revenues increased by 2.1% QoQ & 17.2% YoY in CC terms while dollar revenues were up 0.5% QoQ & 13.3% YoY. The growth was driven by BFSI/communication/consumer verticals. HCL Tech (IT services) reported revenue growth of 2% QoQ & 18.1% YoY in CC term while in dollar terms it reported growth of 0.1% QoQ. Geography wise America region (64% of mix) grew 2.8% QoQ in CC terms while vertical wise growth was driven by technology & services, telecommunications, manufacturing & life science. HCL Tech maintained its guidance of 12-14% revenue growth in CC terms for FY23. Tech M’s revenues increased 3.5% QoQ & 21.2% YoY in CC terms while it was up 1.5% QoQ & 18% YoY in dollar terms. The growth was aided by manufacturing, retail & technology, which grew by 4.2%, 5.5% & 5.9% QoQ, respectively. LTI reported constant currency growth of 2.9% QoQ & 26.6% YoY while dollar revenue increased 1.7% QoQ. The revenue growth was driven by BFSI vertical. Mindtree reported a sixth consecutive quarter of 5%+ constant currency QoQ growth at 5.5% while dollar revenue grew 4% QoQ. The growth was driven by Travel & hospitality, BFSI & technology while geography wise North America (77% of mix) reported growth of 8.5% QoQ. Coforge’s dollar revenue grew 2.7% QoQ & 19.5% YoY while in CC terms it reported growth of 4.7% QoQ. America region reported a growth of 5.6% QoQ while vertical wise the revenue growth was led by BFS vertical with 9.4% QoQ growth. The company increased its revenue growth guidance in CC terms to at least 20% growth from earlier 20% growth in FY23 

- Margins impacted by wage hike for few while supply side challenges for others: Operating margins were impacted due to wage hikes rolled out in the quarter for few companies while for others, it was on account of supply side challenges, increase in sub-contractor expenses as well as in travel & visa related expenses. TCS EBIT margin declined 185 bps QoQ to 23.1% due to annual wage hike, increase in sub-contractor cost & travel expenses. Infosys EBIT margin declined 150 bps QoQ to 20.1% due to wage hike, lower utilisations & higher sub-contractorcost mitigated by currency depreciation & reversal of certain contractual provisions. Infosys maintained its EBIT margin guidance band of 21-23% but it indicated that margins will be in lower end of band. Wipro reported 200 bps QoQ EBIT margin decline to 15.0% due to drop in utilisations, high sub-contractor cost & internal investment. Wipro indicated that its margins have bottomed out and margins will recover from Q2 onwards. HCL Tech’s IT services EBIT declined 180 bps QoQ to 15.7% due to high sub-contractor cost, retention cost & travel related expenses. HCL Tech’s overall EBIT margin declined 90 bps QoQ to 17%. HCL Tech maintained it EBIT margin guidance in the range of 18-20% in FY23 but it has indicated that margins could be at the lower end of band. Tech M’s EBIT declined 220 bps QoQ to 11% due to higher employee cost, higher sub-contractorcost, increase in travel expenses & normalisation of SGA expenses. EBIT margin of LTI declined 130 bps QoQ to 16% due to increase in employee cost & travel related expenses while Mindtree’s EBIT margins increased ~20 bps QoQ to 19.2% due to currency tailwinds and operational efficiency. Coforge’s EBIT margin declined ~300 bps to 12.5% due to wage hike & increase in SGA expenses 

- Net hiring mixed: LTM attrition remained at an elevated level as supply side challenges persisted but some moderation was visible for a few. All companies reported increase in LTM attrition except Wipro & TechM. Hiring trend was mixed as some reported seasonal weakness in hiring while for other hiring continue to be strong. Hiring for Mindtree (fourth consecutive quarter of 1500 fresher additions) as well as for Infosys, Wipro remained strong (net additions of 21,000, 15,000, respectively, for them) while that of TechM, LTI, Coforge, HCL Tech & TCS reported relatively muted net additions. Most IT companies, however, indicated that it will continue with its fresher hiring programme for pyramid optimisation 

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