IT services growth rate is among the slowest over last decade

The growth of the IT services industry is expected to remain weak in 2QFY24, as macroeconomic uncertainty continues to weigh on discretionary spending, as per a report by Motilal Oswal Financial Services.

The softness seen in Q1 should continue across the board with no meaningful signs of recovery or deterioration in Q2. Our IT Services coverage universe should report a median revenue growth of 1.5 per cent QoQ/5.7 per cent YoY in 2QFY24, the report said.

This growth rate is among the slowest observed over the last decade, despite a marginal impact from FX fluctuations. However, a focus on cost-control measures should lead to margin improvement in 2Q. “We continue to prefer Tier-I players (TCS, HCLT, and INFO) over Tier-II, given the former's attractive valuations, payout yield and diversified portfolio”, the report said.

While the industry has witnessed an uptick in order inflow over the past two months with a focus on cost efficiency, the slowdown in project-based business is expected to hamper overall industry growth, even though Q2 is traditionally a robust season for the sector.

We expect Tier 2 IT companies to see further moderation in growth, which can lead to narrowing in the valuation gap (1-year forward P/E) between Tier 1 (median 22x) and Tier 2 (median 27x), the report said.

Margin recovery is anticipated across the board following the completion of wage hikes. A strict emphasis on cost-controlling measures should support margins in Q2.

Additionally, a few select names (under tier-1) have postponed their FY24 wage hike cycles. This strategic decision is expected to support margins in the near-term, the report said.

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