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Margins hold up well despite increasing supply side pressures

Indian offshore techs had a strong Sep’21 quarter with continuing momentum on revenue growth even as margins held up quite well despite concerns in certain industry sections around intensifying supply side pressures as costs of talent and attrition increase. Growth and offshore leverage along with high utilisation aided margins performance yet again even as 1HFY22 net hiring has already exceeded prior annual peaks in line with our thesis ( refer links here and here). Pricing commentary continues to be more constructive and encouraging (albeit global techs suggest greater confidence!). While deal wins were down due to absence of mega deals , companies remain confident of growth momentum led by visibility within existing clients. 2QFY22 results drive revenue/earnings upgrade across majority of the coverage. HCLT and INFO remain the top picks amongst Tier I’s while PSYS and MPHL are top picks amongst Tier II techs.

* Revenue growth motors along; margins hold up despite intensifying supply side concerns: The 2QFY22 report for Indian techs continued the trend of strong revenue growth sustaining across a majority of companies (as they outperformed expectations, with the exception of TCS and HCLT amongst Tier I techs and Coforge amongst the Tier II’s). However the more encouraging part was the fact that the companies (with the sole exception of ZENT) broadly met or exceeded expectations on margins aided by growth leverage, continuing benefit of offshore shift and higher utilisation (this is the most surprising element given that companies have seen 400-800 bps increase in offshore mix which has led to significant offshore hiring and yet companies are making new highs on utilisation)

* 1HFY22 hiring by TWITCH already exceeds prior annual peak hiring: The ‘TWITCH’ group added 86k+ employees at a net level during 2QFY22 thereby taking the total hiring to 144k+ for 1HFY22, exceeding the prior annual peak hiring seen in FY12 ( in line with our view, refer links here and here). Companies continue to indicate greater focus on fresher/junior hiring given that they are seeing increased demand for offshore delivery. Interestingly, utilisation rates have continued to move up higher despite an increasing shift in offshore delivery and strong hiring. We reckon that this is resulting from the demand strength and is a significant margin lever even as attrition and supply side pressures are intensifying.

* Deal wins down due to absence of mega deals; albeit companies remain confident of near term momentum: Certain sections of the street seem to be concerned about the large deal win TCV across companies which has seen some moderation. We however note that this is also resulting from the absence of mega deals (unlike last year when Tier I vendors had won several captive buyout deals like Wipro-Metro, Infosys-Daimler etc.). We continue to believe that this metric has limited utility given the different methodology across companies apart from the fact that this may not capture the mining led growth opportunity

* Slight revenue/EPS upgrades across a majority of universe; sharp YTD up-moves calls for some near term pause: 2QFY22 results drive slight upgrades on revenue/earnings estimates across FY22-24E along expected lines. That said, sharp recent up-moves CY21 YTD are likely to lead to much needed near term pause even as growth momentum sustains that could continue to aid margins/earnings despite the street concerns on increasing talent pressures. We see the sector enjoying a ‘2004-08’ phase wherein the companies were able to limit margin pressures through growth and pricing leverage. HCLT and INFO are top picks amongst Tier I techs while PSYS and MPHL are top picks amongst Tier II techs.

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