IGI Logo

AGIC takeaways: Growth outlook intact; supply-issues transitory

We interacted with 12 IT services companies during our Annual Global Investor Conference (AGIC). The discussion was centered on demand longevity, supply-side challenges, pricing, and the margin outlook. Here are the key highlights:

* The key themes from our interaction are as follows: 1) the demand environment continues to be strong, with traction across industries, and is multi-year in nature; 2) the supply side is overheated on account of the sudden jump in demand, but this is transient and expected to normalize in FY23; 3) companies are seeing select cases of price increases, led by digital engagements; 4) margins should see headwinds in FY22 due to supply-side issues, but normalize over the medium term, aided by growth and operating levers.

* Quess and TeamLease also highlighted strong demand and an increase in attrition in their IT Staffing verticals, indicating good traction across the value chain.

* We continue with our positive stance on the sector and maintain Infosys and HCL Tech as the preferred picks within tier 1 and LTTS within tier 2.

Demand outlook continues to be robust and sustainable

* The overall demand environment is strong, led by an overall increase in tech spending, higher outsourcing intensity, and the addition of new clients.

* Cloud remains the key growth theme, with TCS’ CEO Mr Rajesh Gopinathan highlighting multi-year tailwinds from cloud migration, followed by a long period of investment in cloud-native technologies.

2QFY22 to see strong growth and deal wins, but softening margins

* 2QFY22 is expected to see strong growth and deal bookings, with TechM/HCLT suggesting continued strength in deal wins and HCLT indicating revenue CQGR above 2.8% QoQ in 2Q (implied in the FY22 guidance). Commentaries from Mindtree and LTTS also hinted at strong growth momentum in 2Q.

* Margins are expected to be soft, primarily due to supply-side challenges and continued additions to headcount (HCLT, Infosys, Mindtree, Zensar). On the other hand, attrition, wage inflation, and sub-contracting costs would remain elevated.

Supply-side challenges intense, but transient

* Supply-side challenges have intensified over the past six months. However, most companies see the current supply-side challenges as transient and expect them to ease with the addition of fresher intake and investments in training over FY22.

* Staffing majors such as TeamLease and Quess Corp have further echoed the sentiment of high attrition and supply-side constraints, especially in newer technologies.

Pricing starts to turn favorable

* Given the strong demand and tight supply situation, almost all companies are seeing pockets of pricing strength. Price tailwinds are best in new deals, while it is difficult to renegotiate on existing contracts, especially fixed-price deals.

* TCS is the only exception on pricing as it remains focused on increasing client wallet share and is fine with absorbing the current volatility in costs.

Engineering R&D sees tailwinds

* LTTS and Tata Elxsi highlighted the acceleration of digitization within Engineering Research & Development (ER&D). Growth levers for ER&D services companies consist of 1) higher outsourcing and 2) market share gains by Indian and European ER&D players.

* LTTS revealed that its deal pipeline has increased across the board, led by a higher large-deal pipeline. The nature of deals in the pipeline constitutes cost takeout deals, rebadging deals, joint solutions, and manufacturing and supply chain deals. Commentary from Tata Elxsi was also upbeat on demand.

Cost savings, operational levers, and leverage to support margins

* FY21 has seen strong margin expansion, while ongoing supply-side challenges pose near-term risk to margin performance. However, the medium-term outlook for stable margins continues.

* Key tailwinds to margins comprise 1) continued offshore traction, 2) utilization continuing to trend above pre-pandemic levels, 3) pyramid rationalization, 4) continued cost savings, and 5) operating leverage.

* Key headwinds to margins consist of 1) attrition and wage inflation in select pockets of skill sets and experience bands and 2) sub-contracting expenses potentially being elevated in the near term.

To Read Complete Report & Disclaimer Click Here

For More Motilal Oswal Securities Ltd Disclaimer http://www.motilaloswal.com/MOSLdisclaimer/disclaimer.html SEBI Registration number is INH000000412

Above views are of the author and not of the website kindly read disclaimer