Credit profile of Indian IT services companies to remain

The profitability of IT services companies declined during the first quarter of the current financial year, on account of higher employee expenses especially onsite led by fresh hiring, sub-contracting cost, and cross-currency movements, rating agency ICRA said. Employee expense increased to 61.7 percent in Q1FY2020 from 59.8 percent in Q1 FY2019 for ICRA's sample of 13 companies.

The operating margin during Q1FY2020 remained at 22.6 percent versus 23.3 percent in Q1FY2018 and 22.7 percent in Q4FY2019. The share of fixed-price contracts improved to 58.5 percent in Q1FY2020 compared to 57.5 percent in FY2018 while employee utilization levels remained flattish during the same period for sample companies, being two critical factors associated with generating operational efficiencies.

During Q1FY2020, ICRA sample companies grew by 10.3 percent in Rupee terms while in USD terms it grew by approximately 7.4 percent. During the quarter, the Rupee depreciated by 3.7 percent year-on-year versus USD and appreciated 1.9 percent and 2.1 percent versus GBP/EUR respectively (USA and Europe collectively contribute 85 percent of ICRA sample set revenues).

The net employee additions show a positive trend with approximately 29,305 additions during Q1FY2020 compared to 22,245 in Q4FY2019 and 26,782 in Q1FY2019, ICRA said. Vice President Corporate Ratings, ICRA, Gaurav Jain said demand was being driven by scaling up of solutions built around digital technologies (mobility, social, cloud, analytics and automation).

The hitherto traditional outsourcing services such as custom application maintenance face pricing pressure and ERP (Enterprise resource planning) applications are increasingly becoming consumer-oriented - with application delivery mechanism shifting to cloud-based environments, Jain said. "Adoption of digital technologies has reached an inflexion point and is triggering large scale re-architecture programs," he said.

Among the sectors, banking & financial services continue to see some weakness led by current macro-economic conditions including low-interest rates. The telecom vertical is showing signs of recovery owing to 5G and allied infrastructure development.

With the visa issuance norms being tightened by restricting the entry of entry-level programmers, increasing compliance and evidence requirements adding to cost pressures and fewer issuance of H-1B visas, Indian companies have ramped up onshore hiring in the USA. Higher onsite hiring is associated with higher wage bills and lower margins.

Despite pressure on growth and margins, the credit profile of Indian IT Services companies is expected to remain stable underpinned by its ability to sustain free cash flows, ICRA said. The credit profile is also supported by net cash position with significant liquidity in the form of surplus investments generated out of past cash flows, it said.

Over the next decade, ICRA also expects consolidation in the industry especially among small and mid-size players as margin pressure will intensify leading to lower returns for shareholders. "Geo-Political issues restricting the movement of skilled labor or increase in minimum salary requirement will have a negative impact on the sector outlook," Jain added.