Indian IT companies expected to report soft Q3 as higher furloughs to weigh on revenue growth: ICICI Securities

Indian IT companies are expected to report a "soft" third quarter with higher-than-usual furloughs weighing on revenue growth, industry watchers said cautioning that demand outlook commentary is likely to be unchanged as clients continue to scrutinise discretionary spends and prioritise cost optimisation.

The big earnings week for tech heavyweights is up ahead, with the top tier IT companies slated to announce their December quarter numbers this week. Tata Consultancy Services (TCS) and Infosys will declare their Q3FY24 report card on January 11 (Thursday) and Wipro and HCL Technologies on January 12 (Friday).

All eyes will be on management commentary from the IT pack on prevailing customer sentiments across BFSI, and technology services, as well as demand scenario panning out in key markets of the US and Europe.

"We expect IT companies to report soft quarter-on-quarter constant currency revenue growth in Q3FY24 due to higher-than-usual furloughs for most companies in our coverage universe. We expect margins to be impacted due to furloughs and wage hikes (rolled out by Infy, Wipro, HCLT)," ICICI Securities said in its Q3FY24 results preview.

The signs of improvement in IT spending in the near term remains elusive, with continued scrutiny over discretionary spends and focus on cost optimisation, ICICI Securities further said.

"Though US Fed's recent commentary allays macro uncertainty, an improvement in IT spending in FY25 is already built into our estimates. We now model a slower pace of recovery than envisaged earlier, and thus cut FY25/26 revenue growth estimates by 2-4 per cent for covered companies," it wrote.

It pegged quarter-on-quarter growth for tier-1 IT services between -2.6 per cent and 5 per cent, while projecting 1 per cent to 3 per cent sequential growth for tier-2 players.

"We expect sequential revenue growth to be lower in Q3FY24 versus Q2 due to headwinds from higher-than-expected furloughs, especially in BFSI and hi-tech, as well as continued cut in discretionary spends," it said.

It also expects revenue growth gap between large-cap and mid-cap IT firms to narrow in Q3FY24, as larger portion of mid-cap IT has higher exposure to BFSI (banking, financial services and insurance) and hi-tech, which are impacted by higher-than-usual furloughs in December 2023.

With clients continuing to scrutinise discretionary spends and focus on cost optimisation, demand commentary from IT companies shall likely remain unchanged, it reckoned.

"Given the absence of mega deal announcements in the Dec '23 quarter, we see flat order books on a YoY-basis with a dip sequentially for most companies in our coverage," ICICI Securities said.

Echoing the prognosis for a muted Q3 showing, Motilal Oswal Financial Services in its results preview said the weakness in IT services demand has been "further intensified" by higher-than-expected furloughs in third quarter of FY24. The seasonality is likely to hurt revenue growth and margin performances of both tier-1 and tier-2 IT companies.

"The industry has not witnessed any meaningful change in spending patterns, as discretionary spending continues to take a pause across enterprises. Although sentiment has improved, it has not yet been reflected in actions.

"Our IT services coverage universe should report a median revenue growth of 0.7 per cent QoQ/2.5 per cent YoY (year on year) in 3QFY24," it said. The banking and financial services and hi-tech space is likely to be adversely impacted in 3QFY24, while the other verticals deliver muted performance.

As such, it said, there is no sign of demand recovery in the key geographies of US and Europe, although the situation has not deteriorated materially per se. The majority of the clients are exercising caution and reprioritising their spending.

Motilal Oswal pointed out that the combination of adverse macros and higher-than-expected number of furloughs has extended the timelines for deal closures and executions across companies, leading to slower revenue conversion in the third quarter.

"We expect revenue growth of Tier-I companies to be in the range of -2.7 per cent to +4.5 per cent QoQ in CC (constant currency) terms. Revenue of Tier-II players are expected to grow to the tune of -4.4 per cent to +3.0 per cent QoQ in CC terms," Motilal Oswal said in the report.

Catch the latest stock market updates here. For all other news related to business, politics, tech, sports, and auto, visit Zeebiz.com.