Decoding Q3 FY23 Results: Indian IT Majors, As They Anticipate Slowdown

With Q3 FY23 in the books for the four largest IT companies in India, it’s time to look back at the key metrics that affected the premier companies’ performance with some detailed analysis. The quarter ended 31 December 2022 was a crucial one as we anticipate a slowdown and possible recession this year. 

BW Businessworld got in touch with Sumit Pokharna, Research Analyst, Vice President Kotak Securities Ltd., who broke down the Q3 FY23 numbers posted by Tata Consultancy Services (TCS), Infosys, HCLTech and Wipro. 

How do you view the performance of IT majors in Q3?

TCS reported a broadly in-line quarter. Interestingly, the company has reported revenue growth of 2.2 per cent QoQ and 13.5 per cent YoY, 30 bps higher than our estimate. EBIT (Earnings before Interest and Tax) margin expanded 50 bps driven by INR depreciation. However, deal wins were weak at USD 780 crore (+2.6 per cent YoY) with slowdown in growth and transformation deals and delayed decision making in Continental Europe. Net profit grew 11 per cent YoY and 4 per cent QoQ and was 3.6 per cent lower than our estimate due to forex loss and miss at the EBIT level.

Notably, lead indicators (like headcount addition, order bookings, etc) point towards slowdown and consistent with our expectations. The cost take-out component of deals has increased in the overall deal mix. What it means is that such deals typically have a longer tenure compared to growth and transformation deals. Naturally, decision making on deals slowed down in Europe. TCS management has highlighted that deal pipeline and qualified deal pipeline have increased even as decision making has slowed.

Infosys: Infosys’ revenue growth beat our estimates, while margins missed marginally. Infosys reported good sequential revenue growth of 2.4 per cent QoQ in c/c, 120 bps ahead of our estimate. Surprisingly, the company raised revenue growth guidance once again and is creditable. Interesting to note, deal wins were strong, albeit with higher renewal component. However, many verticals are slowing down and consistent with our view of growth moderation in FY24E.

HCLTech: HCLTech’s revenue and margin beat our estimates due to strong QoQ growth in products in a seasonally strong quarter. Expect manageable slowdown in growth due to moderation in tech spending. Discretionary spending and decision-making have been impacted in the technology, retail and mortgage segments and Europe, which can impact near-term growth. Vendor consolidation and cost-focused outsourcing opportunities are set to increase.

Wipro: Wipro reported a mixed set of numbers – weak revenue growth that missed expectations and a sharp uptick in margins, materially ahead of estimates.

What was the largest revenue driver for IT majors in Q3?

Revenue drivers vary for different companies depending on the geographical presence, service lines, etc. 

TCS: TCS’ revenue growth was solid across geos and verticals on YoY comparison in Q3FY23. On a sequential basis, revenue growth driver was Regional Markets which grew by 7.3 per cent in USD terms, while other key verticals grew in the range of 1.3-3.9 per cent.

Infosys: Infosys’ revenue growth driver was pass-through revenues; cost of third-party items for service delivery increased by USD 5.9 crore QoQ (60 per cent of incremental revenues in the quarter) in Q3FY23. Surprisingly, Europe manufacturing client continues to ramp up. In fact, this segment grew 14.5 per cent QoQ and contributed 44 per cent to incremental revenues in Q3FY23. The energy and utilities vertical reported sharp growth QoQ which also supported revenue.

HCLTech: HCLT revenue growth driver was strength in products (c/c growth of 5 per cent QoQ) and Services (grew 2.2 per cent QoQ in c/c). Sequential growth in services was led by manufacturing, telecom, life sciences and E&U. Europe grew 7.2 per cent QoQ, whereas North America grew at a muted 0.5 per cent.

How do you expect the IT majors to do in the Q4 FY23?

Despite macro headwinds, Infosys has raised FY2023E revenue growth guidance to 16-16.5 per cent from 15-16 per cent earlier. The guidance implies revenue growth of 0.5 per cent for Q4FY23.

HCLTech revised its FY2023 growth guidance to 13.5-14.5 per cent; services growth guidance of 16.0- 16.5 per cent implies QoQ growth of 1.5-3.2 per cent in Q4FY23, in our view. In Q3FY23, Furloughs in financial services clients and slowdown in spending in retail and technology verticals impacted growth, but were made up through strong growth in other verticals. Furloughs in certain APAC clients can get extended in Q4FY23.

TCS: Notably, demand is reasonable in North America and the UK in the medium term but can be impacted in Q4FY23 in North America due to cautious stance of clients. TCS will get a better picture of client IT budgets in the region by March. The pipeline and order book in March will provide clearer indicators. TCV numbers will get an uptick in case the deal gets signed in Q4FY23. Fresher addition will further moderate in Q4FY23 while we expect caution on lateral hiring to remain, which can lead to another quarter of decline in net headcount.

Wipro: Management indicated uncertainty on deal ramp-up timelines, which has perhaps translated into a lower-than-expected Q4FY23E revenue growth outlook of (0.6)-1.0 per cent QoQ, also baking in 1) deterioration in macro and 2) the slowdown in discretionary spends, impacting the consulting business.

ICRA has said that pressure on US and Europe markets could mean moderation in growth of IT sector over medium term-- what do you think?

Macro impact on tech spending will differ by geography as per TCS. Continental Europe will be the highest impacted with decision making significantly slowing down. Demand is reasonable in North America and the UK in the medium term but can be impacted in Q4FY23 in North America due to cautious stance of clients. TCS will get a better picture of client IT budgets in the region by March. The pipeline and order book in March will provide clearer indicators, according to TCS. On the other hand, Infosys has indicated that economic growth is slowing down in Europe. But Europe has been a growth market for Infosys due to investments made in the past 18-24 months and large deals. Further, HCLTech has indicated discretionary spending and decision-making have been impacted in the technology, retail and mortgage segments, and Europe, which can impact near-term growth. Slowdown in decision-making in Europe could have impacted a few signings. Cost take-out mandates are increasing in the unqualified pipeline, and can provide fillip to TCV numbers in FY2024. Some delayed deals in Europe can convert in Q4FY23 and Q1FY24. Expect weak growth in Europe in the next couple of quarters.

What does the outlook seem like as we are one quarter away from FY2024? 

Infosys: With FY2023 almost out of the way and still no clear answers to what will happen in FY2024, inevitably focus will shift to revenue growth guidance of Infosys in FY2024. We believe the company can start off with 6-8 per cent guidance. Many verticals of Infosys are slowing down and consistent with our view of growth moderation in FY2024E. We expect Infosys to get back into 22-23 per cent EBIT margin range in FY2024 and FY2025.

TCS: We believe TCS will get back to pre-Covid level margins of ~25 per cent. We expect 25.1 per cent and 25.3 per cent EBIT margins in FY2024 and FY2025, respectively. Margin levers are well known and include (1) lower attrition, (2) lower subcontractor usage, (3) pyramid rationalization, and (4) further increase in utilization. Pricing and INR depreciation are a couple of key levers that are difficult to predict.

HCLTech: Tech spending growth will likely decelerate, given the impact of the macro on various sectors. HCLTech will not be immune. Large vendor consolidation deals and cost take-out mandates can provide cushion, but with a lag. The longer-term theme of cloud adoption and tech stack modernization is intact and aids growth for HCLTech . We believe HCLTech can match or achieve better industry growth in the services business, and estimate 6.9 per cent and 10.8 per cent growth in FY24 and FY25, respectively. Cost take-out mandates are increasing in the unqualified pipeline, and can provide fillip to TCV numbers in FY24.

How do you see IT majors deal with the slowdown in the coming quarters?

Slowdown will impact companies but we believe Infosys, TCS and HCLTech will manage it better. Slowdown may result in higher cost take-out mandates and can provide fillip to TCV numbers in FY2024. What it means is that such deals typically have a longer tenure compared to growth and transformation deals.