IT Sector: Strong demand to remain buoyant in the long run

 The industry will eventually overcome the supply-side issues in the medium to long-term period if not short term.

One of the sectors that emerged as winners post covid pandemic in FY21 was the ‘Information Technology’ sector. Globally there was a demand for IT-BPM (business process management) services like digital transformation, cloud services, platform building and many others like never before and India became a global hub for providing solutions across global enterprises. Indian IT sector was booming like no other, reflecting in the stock prices.

Its contribution to India’s GDP is about 8%. It was also a winner when it came to FDI inflows. 44% of the total FDIs were made in the Indian IT sector during FY21. The workforce has a major contribution to this particular industry as it is also a major cost for IT companies. The IT sector is the largest employer within the private sector, employing about 5.1 million people. The top three companies alone account for 1.11 million employees as of 31st March 2022.

It also plays a major role in bringing home dollars. The sector is responsible for about 51% of total service export from India. According to STPI (Software Technology Park of India), the software exports by IT companies stood at Rs 1.20 lakh crore in just the first quarter of FY22.

Outlook

It’s not like the IT sector is doing bad at all. The demand is still strong and is likely to remain buoyant in the long run as well. The order books of the companies are looking really strong. Companies are witnessed broad-based growth across segments like banking & financial services, communication, retail, manufacturing and many others. The prospects for the industry as a whole are positive. Even though some global investment/brokerage houses have cut down their outlook on the sector claiming the peak has gone by, we believe that the industry will eventually overcome the supply side issues in medium to long-term period if not short term.

The industry body of the Indian IT sector- NASSCOM, estimates that the industry revenues can reach Rs 27.3 trillion by fiscal 2026 backed by growing demand for newer technologies like cloud and analytics.  

Financial Highlights

The top three companies in the sector by market cap and revenues are Tata Consultancy Services (TCS), Infosys and HCL Technologies in order. The overall sector has reported good growth in FY22 over FY21. We have considered a total of 55 companies in our analysis. The average revenue growth of all these companies is 29.25%, while the operating profit grew at 29.99% and the PAT jumped by 51.85%. However, the top three IT companies performed poorly when compared to the industry. The aggregate revenues grew by 17.16%, and the operating profit and PAT grew by 10.04% and 17.73%, respectively, which is far below the industry.

The operating profit margin is a key indicator in the IT industry. For all the 55 companies, that is 23.85% currently in FY22, contracting by 60 basis points from FY21 margins. For the top three companies, it stood at 27.58%. Although it is quite higher than the industry, it still contracted by 176 basis points from FY21. Infosys CFO, Nilanjan Roy said,” On YoY perspective for FY2023 we do not call out the wage impact. As Salil (CEO) said, it will be a competitive compensation hike. We will differentiate hike in talent and in some places, it will be more broad-based and of course, around that we have a lot of cost optimization which we usually do.”

Although the financial growth is strongly visible across the industry, it is also true that the operating profit margin has taken a hit. Employee cost is the primary reason for margin contraction. As the industry requires a skilled workforce, salary hikes and higher wages have put pressure on the margins. Notably, the attrition rate too has gone up significantly in past couple of quarters.

According to experts, the average attrition rate in the IT sector is hitting a record high of 25%. IT companies are struggling to retain employees and hiring new employees has only added to increasing costs. In a company like Infosys, the attrition rate was as high as 27.17% in March 2022 quarter. Post-covid, the sector had witnessed unforeseen demand for automation, digitization and cloud services. Hence, demand was in full force, but the supply side took a toll and was realized more than ever in Q4. For example, Infosys reported a decline of 7.8% in operating profit, when compared to the previous quarter. Similarly, TCS and HCL Tech reported slight growth of just 1.56% and 3.7% against Q3. In the recent bear market, the long bull run of IT stocks was stopped and the stocks went through a sharp correction.