IT companies resort to variable cuts amid pressure on margins; JP Morgan downgrades Infosys, Tech Mahindra among others

Information Technology (IT) sector has been dragging the market on Tuesday amid reports of IT companies resorting to variable payout cut. The latest to join the league of IT giants to cut variable was Infosys. The second-largest Indian IT company has slashed the average variable payout of employees by 30 per cent for the June quarter amid pressures on margin. The pressure on margin was attributed to rising attrition in the sector.  

In order to reduce pressure on margins, IT companies are either delaying or cutting variable payout. Earlier, IT behemoth Tata Consultancy services (TCS), which reportedly delayed variable payout, said TCS have come across completely incorrect reports on our compensation. "Variable pay is either paid in month one or month 2 as per the normal process and there is no delay in this process. 100% VA is being paid for Q1,” TCS spokesperson said.   

Reacting to variable payout cut and pressure on margins, global brokerage house JP Morgan downgraded Infosys, Tech Mahindra, Mphasis and Persistent Systems  

JP Morgan downgraded Infosys to Neutral from Overweight for target price of Rs 1600.  

Besides, it maintained an Underweight stance on Wipro and TCS for target prices of Rs 340 and Rs 2800 respectively.  

Meanwhile, reacting to variable cut by Infosys, Nifty IT declined as much as 2.3% in the afternoon trade on Tuesday, with the majority of the leading IT stocks trading in the red. Infosys and Tech Mahindra were top losers in the IT pack.  

As per brokerage house ICICI Securities, IT companies reported miss on margins and largely in-line revenues, with the exception of Infosys, MTCL and Tata Elxsi in Q1FY23.  

Margins shrank due to supply side pressures as attrition is still at elevated levels – higher-than-normal wage hikes, hiring costs and sub-con costs, it said. Besides, the dip in utilisation due to the large induction of freshers in the past two quarters and the increase in travel and other discretionary costs are also weighing on the IT companies.  

Revenue growth was healthy in CC terms in Q1FY23 for most IT companies with average revenue growth of 3.5% QoQ CC for tier 1 IT and 3.8% QoQ CC for tier-2 IT driven by ramp up of deals won in earlier quarters 

It expected the impact of weak deal wins and client budget cuts to hit revenue growth with a lag. "Our estimates/multiples already bake in slowdown in growth in FY24E," said ICICI Securities.  

Saying we continue to prefer stocks that are less vulnerable to slowdown and have the potential to continue gaining market share, it picked TCS, Infosys, MTCL, Persistent Systems and Coforge as preferred picks from the IT space. 

As per Edelweiss, Margins increased across the companies led by the pandemic and WFH- led savings (travel etc.). However, this has started reversing with travel opening, but the bigger pain is high-attrition leading to a substantial jump in employee costs led by higher replacement costs and jump in sub-contractor costs.