IT cos stave off earnings downgrade challenge

Constant currency growth remained strong, though the impact of cross-currency headwind continues. Deal wins and order flows remained healthy, improving the outlook for companies in the second half of FY23 amid recession concerns.

“So far, the IT sector led to a good start to this quarterly season, with TCS, Infosys and HCL having reported much better results than Street estimates. All of them reported a strong beat on margin, with sturdy topline growth,” said Aishvarya Dadheech, fund manager, Ambit Asset Management. Mid-sized companies like Mindtree and Cyient also reported much better numbers, Dadheech added.   

Easing operational challenges and margin recovery remained a key highlight, which helped improve sentiments more than revenue growth, said analysts. Supply side issues are getting resolved.

Improvement in margins for most companies in Q2 is attributed to cost optimization, currency depreciation and normalization of subcontracting costs.

High attrition that remained a major concern for investors is showing signs of easing. With easing supply-side pressures, the mean reversal of attrition is visible in Q1-Q2 FY23, which will immensely help in margin expansion in the coming quarters, said Dadheech.

Analysts said the improvement in attrition rate will be more visible, going ahead. The cost of replacements has also fallen. In fact, more employee additions by companies such as Infosys remains encouraging, and added to the positive outlook, said Apurva Prasad, institutional research analyst, HDFC Securities Ltd.

Overall, order wins have improved the outlook in the second half, wherein macro challenges were expected to impact the most, said analysts. Factors that have been leading to earnings downgrades in recent times are also improving, as margin pressure eases, said Prasad. It is positive and can help sectors command better valuation multiples over the coming days, too.

“The surprise element was HCL and Infosys raising their revenue guidance for FY23. This is a reflection of the optimism on growth despite concerns arising from the potential fallout of the economic slowdown in the US and Europe,” said Dr V.K. Vijayakumar, chief investment strategist, Geojit Financial Services .“Overall the Q2 results of IT majors were better than Street expectations on most parameters.”

Currency headwinds, however, continued to impact. While the stronger dollar is a positive for the sector, weakening European currencies such as the euro and pound, are minimizing the benefits, at least partially, analysts said.

Currency tailwinds are being provided by a stronger dollar despite other currencies weakening. Currency tailwinds have provided 80 basis points positive rub off, said Omkar Tanksale, senior research analyst, Axis Securities. More than 40% of industry revenue are dollar-denominated. However, the lower attrition rate remains a bigger positive, said Tanksale, because employee costs contribute about 65% to the costs.

Other positives, according to Tanksale, is that demand remains strong and even European regions performed well. This is indicative of the robustness of the business structure of IT services companies, he added.