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We parsed through the result commentary of some of the global system integrators who reported in Feb – Capgemini (CAP FP; NR), Globant (GLOB US; NR), EPAM (EPAM US; NR) and Endava (DAVA US; NR). Three trends come out. One, delayed decision making witnessed in December spilled over to January as well. But February has seen rebound of sorts with higher enquiries, pipeline backfill, deal closures improving. This is driving most players’ backended growth acceleration assumption for 2023. Two, impact on industries remain uneven. Hi-tech, led by “West Coast Tech”, remains under pressure and is likely to see another quarter of decline. Travel, on the other hand, remains strong. Three, mid-sized companies are seeing client specific ramp downs. This could be attributed to either a) impact of such ramp-downs is more pronounced in mid-cap companies with higher concentration; and/or b) mid-cap companies are at the receiving end of vendor consolidation scenarios, in our view. While caution abound, February trends suggest near-term demand might be stabilising. Our checks also indicate clients are selectively re-evaluating budgets/programs which were paused. IT Service’s clients, like investors, are watching central bank’s actions and economic data. Any signs of dovishness could open up demand valves. That said, there is enough uncertainty to believe sector is not completely out of woods yet. Safety in large caps and selective exposure in mid-caps is our preferred positioning in the sector.

* Demand environment – Feb-Pivot?: Players’ commentary indicated that December demand was plagued by elongated decision cycles and delayed ramp-up of closed deals. Indecision and spending caution continued in January. However, there are early signs of these trends reversing in February, per these companies. GLOB commented that not only are large contracts coming back into the pipeline, but they have started closing some of the large deals. DAVA said some of delayed projects are being signed up and starting back. EPAM’s clients who ramped down have come back asking for new teams.

* Outlook – a year of two halves: Players guidance/outlook suggests 2023 is going to be a year of two halves. A slow start to the year is driving near-term caution for most players. However, most players expect back-ended growth to the year buoyed by recent deal closures, new RFPs etc. CAP expects positive momentum to return only in Q4 (at the top end of its 4-7% growth guidance for 2023). GLOB expects 4% QoQ decline in Q1CY23 (led by hi-tech) before returning to growth in Q2. EPAM expects slow growth in 1HCY23 and acceleration in 2H (YoY basis), approaching high teens by Q4. DAVA (YE June) cut its FY23 guidance from 23-24% to 19-20%, citing near term headwind in Hi-Tech. That said, these guidance bake in conservatism. CAP’s lower end of guidance factors further deterioration (-0.25% implied CQGR). GLOB’s 12% organic CC revenue growth guidance for CY23 has built moderated start to the year, as per the management.

* Ramp-downs – Mid-cap’s Achilles Heel: Many of the mid-sized players are beset by client specific ramp-downs. GLOB expects some hit in its top account Disney as it realigns its strategy. DAVA is witnessing slowdown in FIS, one of its top-10 accounts, due to FIS’ internal restructuring. EPAM has seen revenue reduction in its previous top-20 Hi-tech account and unexpected ramp-down in a previous top-10 healthcare account. Such ramp-downs are expected in current weak macro. But their impact tends to be more pronounced for mid-cap companies. A potential vendor consolidation away from these mid-caps also can’t be ruled out

* Read-through for Indian IT Services: Weakness spilling over to January mean 4QFY23 could remain soft for Indian IT Services’ players. Almost unanimously, everyone indicated sustained stress in Hi-Tech. This could put LTIMindtree’s (28% exposure to Hi-tech) 4Q growth under pressure, in our view. Improved deal pipeline, pick up in activities/enquiries bode well for FY24 growth outlook. Larger players with diversified portfolio are better placed in current environment of shifting demand profile (discretionary to cost take-out), uneven impact on verticals/clients and vendor consolidation, in our view. We advise safety in large caps (INFO/TCS) and selective exposure to mid-caps. Within Mid-caps, companies with favourable vertical mix (COFORGE) and differentiated proposition (PSYS) are better bets. WPRO remains our medium-term pick on structural internal improvements.

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