IT cos seen logging steady sequential growth in Q2; all eyes on management cues for demand outlook

Indian IT services companies are expected to log steady sequential revenue growth in the September quarter but an overhang of weak global cues tinged with macro risks will put the spotlight on management commentary around deal momentum and demand outlook, say, analysts.

Brokerage reports and analysts' notes on the Q2 earnings preview anticipate a reasonably strong growth quarter for Indian IT firms despite challenging macroeconomic scenarios in the US and Europe, but there are a fair bit of warnings around ''incremental pockets of weakness'' or ''slowdown in coming quarters''.

The sunny, all-bullish demand narrative just a few quarters back has made way for more cautious and tempered expectations as storm clouds over the global economy prompt economic commentators to flash warnings about recession risks and international market shocks.

Reports suggest that the US-based companies, including many tech firms, have cumulatively laid off thousands of employees in 2022 alone, and slammed the brakes on hirings.

Back home, market watchers are divided in their opinion on whether the cost optimization agendas of the US and European companies will continue to yield significant outsourcing gains in favor of Indian service providers in coming quarters, enough to offset any slowdown or pause on discretionary IT spending by clients under duress.

Tech industry veteran and former director of Infosys, Mohandas Pai asserts that the Indian IT sector is in a ''sweet spot''. The demand outlook is slightly lower than the last quarter due to global uncertainty, but remains ''fairly strong'', he says.

''We are seeing many companies in the US lay off people, which means they are trying to cut costs...If they are trying to cut costs they will outsource more. Indian IT is in a sweet spot because if the market grows, the demand for them grows and if the market falters, people cut costs and outsource more although there will be a lag of 2-3 quarters before they see results,'' Pai told PTI.

The big earnings week for tech companies is up ahead, with Tata Consultancy Services (TCS) slated to report September-quarter results on October 10, followed by HCL Technologies and Wipro on October 12, and Infosys and Mindtree on October 13.

Emkay Global, in a note last week, said that Q2 growth momentum would remain steady but incremental data points such as job losses/freeze at client organizations, and an elongated sales cycle highlighted by some global software majors, indicate a slowdown in coming quarters.

''We expect revenue growth of 2.5-4.5 percent (constant currency) quarter-on-quarter for Tier-1 IT services companies and of 0.1-5.3 percent for Tier-2 firms, in the September-22 quarter,'' it added.

Further, it expects the usual seasonality in fiscal's second-half growth ''to be amplified by a potential weak demand''.

IIFL Securities has forecast that an average sector revenue will grow 3.8 percent quarter-on-quarter in Q2FY23 driven by strong order books and IT demand shifting more towards outsourcing from consulting.

''However, 2H (second half) growth can be a tad soft, as we enter into a seasonally-weaker period amid macro risks,'' it said and observed rising macro uncertainties pose risk to the sector, even as supply-side pressures ease off.

According to an HDFC Securities report, Tier-1 IT is expected to deliver sequential growth in the range of 2.4 to 4 percent in constant currency.

Cross-currency impact severity will be similar to last quarter. ''Although a larger band (0.9 percent to 5.3 percent quarter-on-quarter), mid-tier IT's growth outperformance (versus Tier-1) is expected to continue in Q2,'' it said.

The deal-win momentum, impact of macro indicators on demand/decision-making, markers on technology budgets for calender 2023, demand trends in key verticals such as banking, financial services, and insurance, as well as retail, manufacturing, and communications, besides attrition and hiring trends, will be key monitorable.

Analysts will be also keenly watching out for management commentary on segments exhibiting weak demand trends. BNP Paribas believes that fears of macroeconomic weakness are not reflected in demand and that the structural drivers are intact.

''We do not see the fear of a macroeconomic slowdown stalling business-critical tech modernization. We continue to see faster digital adoption driving strong medium- to the long-term growth of the sector,'' its sector report on India IT services pointed out.

Others feel that the next few quarters could throw up posers if clients enter wait-and-watch mode on new IT projects or pause decisions on discretionary tech spending, amid recessionary pressures in the global economic environment, driven by high inflation, exchange rate volatility, and rising interest rates.

Goldman Sachs, in a report last month, had said the slowdown in discretionary IT services spending around the growth and transformation agenda will be quite material and something not yet completely reflected in the street's double-digit revenue growth forecast for the industry for FY24.

The Indian IT sector benefitted from three secular tailwinds during the pandemic -- outsourcing, offshoring, and digitalization on the back of accelerated cloud migration.

''Given the upcoming macro slowdown (not recession) our macro team expects, which is percolating down multiple leading demand indicators, we believe Indian IT sector USD revenue growth will start to materially slow down from here, weighing on the secular tailwinds highlighted above,'' Goldman Sachs had said in a note dated September 13.

In terms of industry verticals and geographies, it expects a material slowdown in telecom, retail, and utilities, with the European Union seeing a sharper slowdown than North America. Industry expert Ganesh Natarajan believes that mission-critical and maintenance work will continue to grow, and digital, too, has gone mainstream.

''The belief is that Indian IT is so embedded in most large corporations that if there is a slowdown, they will probably outsource more work to Indian IT companies. If they see signs of recovery, the discretionary spending will be back. So in a sense, we are kind of insured...because it will mean business,'' he says.

(This story has not been edited by Devdiscourse staff and is auto-generated from a syndicated feed.)