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Published on 29/06/2022 12:43:42 PM | Source: Motilal Oswal Financial Services Ltd

IT Sector Update - Moderation in operational data to weigh on sector expectations By Motilal Oswal

Posted in Broking Firm Views - Sector Report| #IT Sector #Sector Report #Motilal Oswal Financial Services Ltd

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Moderation in operational data to weigh on sector expectations

Demand commentary remains robust

ACN reported a better than expected 3QFY22, with revenue growing 27% YoY in constant currency (CC) terms. It also upgraded its FY22 revenue growth guidance by 100bp at the mid-point, although its 4QFY22 revenue guidance missed consensus estimates. We view the read-across as mixed. While strong revenue growth and commentary on the pipeline is positive for the IT Services sector, weak employee addition (lowest in the last six quarters) and moderation in deal bookings (-13% QoQ) should dampen the demand outlook.

 

3QFY22 earnings snapshot – Beat on revenue

* Strong operating performance: Revenue, at USD16.2b (up 27%/22% YoY in CC/USD terms), was above the management’s guidance and Bloomberg consensus estimates. ACN reported good deal bookings at USD17b (book-to-bill ratio of 1.1x), up 15% YoY (Consulting/Outsourcing up 14%/5% YoY), although it was down 13% from its 2QFY22 peak - the first double-digit sequential dip in the last two years.

* Consulting continues to outpace Outsourcing: ACN reported a strong growth in both segments, with Consulting/Outsourcing up 30%/23% YoY in constant currency terms.

* Revenue guidance: ACN upped its FY22 revenue growth guidance to 25.5-26.5% from 24-26% YoY in CC terms (100bp upgrade at the midpoint), while keeping the inorganic impact stable at 5%.

* Operating margin: EBIT margin rose 10bp YoY to 16.1%, and the management maintained its FY22 margin guidance at 15.2%

* Net additions were low: ACN added ~12k employees in 3QFY22, the lowest employee addition in the last six quarters.

 

The management commentary provides comfort on near-term demand

* Demand environment: The management indicated a healthy pipeline and strong spends in the areas of Digital, Cloud, Sustainability, and Security. While it did not indicate any slowdown in demand due to a weakening macro environment, it sees a shift in spends towards cost savings as against a growth focus earlier. We view this as a positive for its Indian IT Services peers as cost optimization is a key driver of offshoring.

* Pricing continues to remain a factor: The management sees continued scope for price increases, although the quantum will continue to trail the inflationary impact from compensation hikes. It expects the impact of price hikes to support margin with a lag.

* Unexciting 4QFY22 guidance to add to macro concerns: While ACN revised its FY22 guidance up by 100bp (at the midpoint), it guided at 20-24% YoY CC growth in 4Q, down from 27% in 3QFY22. The upper end of its guidance was lower than consensus estimates, which is likely to add to concerns about the impact of a deteriorating macro-economic environment in the US and Europe.

* Expect stable margin: ACN guided at a margin of 15.2% in FY22. Along with a good pricing environment, a strong operating leverage will help the company maintain its margin, despite the headwinds on account of supply pressures.

 

Key highlights from the management commentary

* ACN had 18 clients with bookings of more than USD100m. Strong bookings were visible across Consulting and Outsourcing segments.

* The pipeline remains strong, and the management did not indicate any impact from a weakening macro environment.

* It guided at a 4QFY22 revenue of USD15b-15.5b, implying 20-24% YoY CC growth and a FX impact of -8%. It expects a margin of 15.2% in FY22.

 

Outlook for the Indian IT Services sector stays intact

* ACN’s commentary suggests that the demand environment remains supportive, and the weakening macro environment has not yet started impacting growth in the sector. While supply-side challenges remain a point of concern, with elevated attrition and lower headcount addition, ACN’s margin guidance implies a stable margin performance in FY23. We maintain our positive stance on the sector as we expect sustained growth with stable margin. INFO, HCLT, and TCS remain our preferred picks within the Tier I IT space.

 

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