However, profit margins to moderate owing to wage inflation: ICRA

Bengaluru, NFAPost: With strong demand for digital technologies resulting in higher award of contracts, ICRA expects the $revenue growth for ICRA sample of IT services companies to be around 9-12% in FY2022, while growth in FY2023 will be around 6-9%

OPM improved in FY2021 owing to lower overheads and higher offshoring; OPM to moderate in FY2022-FY2023 owing to wage inflation and gradual resumption of work.

The $revenue growth of ICRA’s sample of IT services companies is expected to be around 9-12% in FY2022, driven by robust demand for digital technologies resulting in higher awards of contracts.

Further, the growth in FY2022 will be supported by pent-up demand of FY2021, which was lower due to the initial impact of Covid-19. For FY2023, the ratings agency estimates the growth to be around 6-9%.

In Q1 FY2022, the ICRA sample of eight companies recorded a revenue growth of 18.1% in rupee terms and 16.2% in $ terms, primarily led by low base of last year (Covid-19 impact) and acceleration of digital outsourcing deals amid the pandemic.

The rupee appreciated by 2.8% vis-a-vis the US dollar on a Y-o-Y basis, which negatively impacted the revenue growth of IT services companies in rupee terms in Q1 FY2022. In FY2021, the sample of 13 companies witnessed a Y-o-Y growth of 5.9% in revenues in rupee terms and 0.6% in US dollar terms, impacted by the pandemic. In FY2021, the rupee depreciated by approximately 4.7%/7.7%/9.8% Y-o-Y vis-a-vis the US$/GBP/EURO, respectively, which supported the growth in rupee terms.

Based on the trends, ICRA Vice President & Sector Head Gaurav Jain said IT services companies have managed to overcome supply-led challenges through uninterrupted delivery of IT services, through the work-from-home model.

“As a silver lining, the pandemic is accelerating the secular trends of core modernisation, usage of collaborative technologies and cloud migration as companies shift to digital business models to pursue work-from-home model, which will benefit the IT services companies,” said Gaurav Jain.

In H1 CY2021 (January-June 2021), traditional sourcing witnessed annual contract value (ACV) of $15.2 billion, up by ~15% on a Y-o-Y basis, owing to accelerated demand for digital technologies.

Gaurav Jain said enterprises have shifted to virtual models that have pushed the acceleration of digital outsourcing deals.

“Further, risks related to H-1B visas issuances have slightly abated with the election of the new US administration in February 2021. Several proposed changes with respect to visa eligibility, wage levels and selection procedures have been put on hold for further review or deferred or vacated by the court,” said Gaurav Jain.

In Q1 FY2022, the operating profit margin (OPM) for the ICRA sample set (comprising eight companies) was 24.9%, lower than 25.6% in Q1 FY2021, impacted by wage inflation. The OPM in FY2021 (sample of 13 companies) at 24.2% (22.7% in FY2020) remained supported by depreciation of the rupee against the US dollar and lower overheads owing to the pandemic.

The improvement in OPM witnessed in FY2021 is unlikely to sustain going forward owing to wage inflation, pricing pressure on legacy services and gradual resumption of normal office working and travel compared to work-from-home options seen during FY2021. ICRA expects the OPM for its sample set to taper off to 23.0% in FY2022 and 22.5% in FY2023. Despite lower OPM compared to FY2021, it is expected to remain healthy.

“ICRA has a Stable outlook on the Indian IT services industry, underpinned by its ability to generate healthy free cash flows, it also expects the companies to distribute 75-85% of their profits in the form of dividend and share buybacks, in line with the past few years’ trends,” Gaurav Jain added.

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