IT saw steady sequential growth in the second quarter; all eyes on demand prospects

Indian IT services companies are expected to see steady sequential revenue growth in the September quarter, but an overhang of weak global indices tinged with macro risks will highlight management’s comments regarding deal dynamics and the demand outlook, according to analysts.

Brokerage reports and analysts’ notes on the second quarter earnings preview forecast a quarter of reasonably strong growth for Indian IT companies despite a difficult macroeconomic scenario in the United States and Europe, but there are quite a few warnings about “additional pockets of weakness” or a “slowdown in the coming quarters”. .

The sunny and entirely bullish demand narrative of a few quarters ago has given way to more cautious and tempered expectations as storm clouds over the global economy prompt economic commentators to issue warnings about risks of recession and shocks on international markets.

Reports suggest that US-based companies, including many tech companies, laid off thousands of employees in 2022 alone and held back hiring.

Back home, market watchers are divided on whether the cost optimization programs of US and European companies will continue to generate significant outsourcing gains for Indian service providers in the coming quarters, sufficiently to compensate for any slowdown or pause in discretionary IT spending. by customers under duress.

Tech industry veteran and former Infosys executive Mohandas Pai says India’s IT sector is in a “sweetspot”. The demand outlook is slightly lower than last quarter due to global uncertainty, but remains “pretty strong”, he says.

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“We see a lot of companies in the US laying off, which means they are trying to cut costs… If they try to cut costs, they will outsource more. Indian IT is in a perfect situation because if the market grows the demand for them grows and if the market falters people cut costs and outsource more, although there will be a lag of 2-3 quarters before you see results,” Pai said. at PTI.

Big earnings week for tech companies is ahead, with Tata Consultancy Services (TCS) set to report September quarter results on October 10, followed by HCL Technologies and Wipro on October 12, and Infosys and Mindtree on October 13. .

Emkay Global, in a note last week, said second quarter growth momentum would remain flat, but additional data points such as job losses/freeze in client organizations, an elongated sales cycle set in motion. evidence by some global software majors, point to a slowdown over the coming quarters.

“We expect revenue growth of 2.5-4.5% (constant currency) quarter-over-quarter for Tier 1 IT services companies and 0.1-5.3% for Level 2, in the September 22 quarter,” he added. .

In addition, he expects the usual seasonality of fiscal second-half growth “to be amplified by potentially weak demand.”

IIFL Securities forecast average industry revenue to grow 3.8% quarter-over-quarter in Q2FY23, driven by strong backlogs and IT demand shifting more towards outsourcing advice.

“However, growth in 2H (second half) may be a little weak as we enter a period of seasonal weakness amid macro risks,” he said and observed that rising macro uncertainties were a risk. for the sector, even if supply-side pressures eased. .

According to a report from HDFC Securities, Tier 1 computing is expected to generate sequential growth in the range of 2.4-4% in constant currency.

The severity of the currency impact will be similar to last quarter. “Although a wider band (0.9% to 5.3% quarter-over-quarter), mid-tier computing growth outperformance (vs. Tier 1) is expected to continue in the second quarter,” he said.

Momentum from completed deals, impact of macro metrics on demand/decision making, markers on technology budgets for the 2023 timeline, demand trends in key verticals such as banking, financial services and insurance, as well as retail, manufacturing and communications, in addition to attrition and hiring trends will be key items to watch.

Analysts will also be watching for management commentary on segments showing weak demand trends. BNP Paribas believes that fears of macroeconomic weakness are not reflected in demand and that structural drivers are intact.

“We don’t see fear of a macroeconomic downturn blocking the modernization of business-critical technologies. We continue to see faster digital adoption driving strong mid- to long-term industry growth,” its industry report noted. on IT services in India.

There are others who think the next few quarters could spell trouble if customers enter a wait-and-see mode on new IT projects or put decisions on discretionary technology spending on hold, amid recessionary pressures in the global economic environment. , driven by high inflation, exchange rate volatility and rising interest rates.

Goldman Sachs, in a report last month, said the slowdown in discretionary IT services spending around the growth and transformation program would be quite significant and something not yet fully reflected in the two-way growth forecast. industry revenue figures for FY24.

India’s IT sector has benefited from three age-old tailwinds during the pandemic: outsourcing, offshoring, and digitalization through accelerating cloud migration.

“Given the upcoming macro slowdown (not recession) that our macro team expects, which is impacting several leading demand indicators, we believe that India’s IT sector USD revenue growth will begin to slow significantly. from here, weighing on the secular tailwinds highlighted above.” Goldman Sachs had said in a note dated Sept. 13.

In terms of industry verticals and geographies, he expects a significant slowdown in telecommunications, retail and utilities, with the European Union seeing a steeper slowdown than North America. Industry expert Ganesh Natarajan believes that critical and maintenance work will continue to grow, and digital has also become mainstream.

“The belief is that Indian IT is so embedded in most large companies that if there is a downturn, they are likely to outsource more work to Indian IT companies. If they see signs of recovery, the Discretionary spending will be back in. So in a way, we’re kind of insured…because it means business,” he says.

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