IGI Logo

Easing of supply pressure to aid FY24 earnings

* Near-term demand to remain soft…: Technology-related spends are likely to remain muted over the near term led by challenging macro environment and concerns on stability of the overall Banking industry (trouble in Credit Suisse and a few of the US regional banks).

* …but long-term demand intact: With an already high base (strong spends in FY22 and FY23), this would result in a muted industry topline growth for FY24E. However, we expect the peak of weak macro impact to play out by 1HFY24 before recovering gradually in 2HFY24. With structural demand remaining intact, we continue to expect a strong demand recovery in FY25.

* TCS – the prime beneficiary: The adverse impact of IT-related spending cuts should primarily be on discretionary spends, which have been the key spending area post Covid-induced disruptions. On the other hand, cost optimization and vendor consolidation-related spends should remain the prime focus over the next 3-4 quarters, which we see as positive for TCS – our top pick in CY23.

Weakness in global banking environment to hamper near-term spends

* Though IT spends have remained resilient, rising interest rates and current trouble in the US banking system imply adverse near-term impact for IT spends.

* We expect the banks to maintain caution and curtail discretionary technology spending until the situation stabilizes. This would hit IT spends in the early part of FY24 and exert further pressure on near-term growth outlook for IT services.

* We remain watchful of the situation and any further weakness in banking ecosystem would be viewed negatively. We have cut our FY24E/FY25E EPS for tier-1 players by 0.4-3.9%/0.8-3.7% due to their near-term weaknesses.

Margin recovery would continue to play out

* With industry hiring ahead of the curve in anticipation of strong demand and high attrition, most of the companies took hit on profitability during the current year.

* However, moderation in hiring, lower backfilling costs due to easing attrition rates, lower sub-contractor expenses and normalization in salary cost for employees should support margin expansion in the medium term.

* Our estimates indicate that the recovery in growth from 2HFY23 and 100bp margin improvement over FY23-25 should drive the industry’s earnings growth.

Continue to prefer tier-1 over tier-2 players

* The macro headwinds in the US and Europe could have an adverse impact on near-term growth for the IT services companies. However, considering the scale of offerings, top-notch client profile and execution prowess, we believe that tier-1 companies are better placed in a weakening demand environment.

* This trend has already started to play out in the recent quarter, with tier-1 players outpacing (Exhibit 21) their tier-2 counterparts in terms of revenue growth.

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