TCS & Infosys may see 100 bps and 60 bps sequential improvement, respectively: Abhishek Bhandari

"Some mid-caps, where salary hikes were not given in Q1 and were planned for Q2, could see a downside of around 90 to 100 bps. Such can be the case for the likes of MindTree and Persistent. But overall the bottom of margin is largely made, though the pace of recovery of margins would be slow," says Abhishek Bhandari, Senior Equity Research Analyst, Nomura. Edited excerpts.

Well this time around, I am guessing, the focus will be more on commentary rather than numbers. What are the things that you are watching out and what is your expectation, will the commentary really turn cautious?
We expect the companies’ commentary to turn decisively cautious. Some of the early indicators for the cautiousness are coming from the fact that the end-clients for the Fortune 2000 companies are slowing down on revenues. The guidance which Accenture put out a couple of weeks ago also indicates a meaningful deceleration between the two years, though the good news is that the growth rate might still be better than pre-Covid levels. In terms of the commentary, I think the companies will start talking more about clients trying to prioritise cost optimisation for the projects over the long-term digital projects in the real term, given that the inflation is really biting some of the consumer-facing industries more than the others.

But in terms of the margin profile of a company, last quarter was exceptionally bad and the expectations were that it is going to be the worst. Do you expect further downside pressure for the margins this time around, or are we going to see a bit of reversal given that the wage hikes have normalised?
You are right, you know the companies which have given salary increments in Q1 are likely to see a significant improvement in margins though I would say the pace of recovery of margins would be lower than the pre-COVID times, given that the attrition levels are still running high. In particular, among the large-caps, we think TCS could have almost 100 bps sequential improvement and Infosys could have around 60 bps sequential improvement. Some mid-caps, where salary hikes were not given in Q1 and were planned for Q2, could see a downside of around 90 to 100 bps. Such can be the case for the likes of MindTree and Persistent. But overall the bottom of margin is largely made, though the pace of recovery of margins would be slow.

What is your outlook on the management commentary because that has turned fairly cautious compared to what we saw in Q4 of FY22? Do you expect this kind of a stance to continue into Q2 as well?
First, from a very near term point of view, I think the management has started talking about the usual furlough cycle in Q3, keep in mind that the last two years did not really have too many furloughs because the clients were trying to prepare themselves for Covid-related challenges. This year, we likely see a normal furlough season to that extent. You know there would be some slowdown between Q2 and Q3 from a very near-term perspective. From a next calendar year perspective, the companies keep saying that clients typically finalise the budget sometime in December and January, but we do get some early feelers about what the clients are thinking. I think we put out a note sometime in early September where we argued, based on our channel checks, that this time around the bite of inflation is actually significantly high. Among the three-four sub-sectors of technology, which could see a lower spending from next year’s perspective, technology spending, particularly in IT services, figures in the top four. So definitely there is going to be cuts in the budgets, there will be more priority given to making more returns out of the investments particularly around cost optimisation. The pressures probably will be more in terms of consumer facing factors like retail and the interest rates sensitive sectors like mortgages.

The one thing most investors and market experts probably are wondering is if indeed the attrition or the hiring trends are not at par with what the market is anticipating, would you be reading too much into it?
Well, I do not think so. There is always a lag between the attrition levels and the demand slowdown. I think the demand is slowing down is a fact and attrition typically slows down with one or two quarters’ lag. I think we are towards the peak of attrition numbers between Q1 and Q2 and do remember this typically also is the annual appraisal cycle for many companies and many young employees go for their higher studies in the western world. So, typically, Q1 and Q2 tend to have attrition but as things stand the way some of the companies have stopped hiring. The way new tech start-ups are going through funding freezes, there is a meaningful deceleration in the overall tech department. That should translate into better attrition numbers from a company’s point of view. On the hiring part, we have already seen that the numbers are slow on the net and gross basis. Companies are still sticking to their broad numbers about hiring from campuses, which is around 40,000 to 50,000 for TCS and Infosys. I think they are going to honour those commitments but the net hiring might be slow given that the demand is slowing down.

Also wanted to get a sense from you that the double-digit revenue growth that you are pencilling in for FY23, is that at risk? And for FY24, would we go back to the single digit revenue growth?
From FY23 perspective, our thinking is that there is more likely to be margin pressure here rather than growth pressure. I think most of the calendar budget for CY22 from clients is still in flush-out mode, which is good news from IT services point of view. That is why if you look at Q1 numbers and even Q2 numbers, it is unlikely that companies will disappoint on growth figures. However, come next year, I think you know we expect the sector’s overall growth rate to come down from close to 11% to 12% in FY23 to around 9% next year. There will be a dissimilarity in performance between companies. For example, we expect TCS to grow the weakest and Infy to grow the fastest even next year based on what kind of booking these companies have been doing. But in context a 9% growth next year on a CC basis might still be better than pre-Covid numbers of around 7 to 8%.