Uncertain Macros Weighing Down On FY25 Outlook For The IT Sector: Prabhudas Lilladher

Prabhudas Lilladher (PL), one of India's most trusted financial services organisations in India, in its latest Information Technology (IT) report cited that the revenue growth outlook for FY25 has been discouraging with Tier-1 companies expected to report below mid-single digit growth on average, while Tier-2 companies are capping their revenue growth to high-single digits. Unlike in FY24, companies have become more conservative in FY25 projections, and are baking in anticipated delays in executions and project closure activities. However, if the spending recovery coexists with an anticipated macro recovery in the near-term, then we might see an upward revision to the estimates for the companies as they progress through the year.

The report states that FY24 ended with another quarter of weak performance within IT services. Although the revenue growth was largely in-line or a tad below consensus, the margin improvement or earnings growth was disappointing for selective names. Median revenue growth for the IT sector (Tier-I + Tier-II) came in at +0.7% QoQ CC, wherein Tier-2 companies continued to outpace Tier-1 names and have reported median CC growth of 2.1% QoQ, while Tier-1 revenue growth came in at -0.6% QoQ CC.

The volatility within key verticals (BFSI, Retail and Communications) continue to affect topline performance, although majority of the companies have reported either muted or positive USD growth within BFSI (median +1.9% QoQ), while Retail growth was weak (median –2.3% QoQ). The operating margin was flat QoQ for the sector at 19.7%. Margins for both Tier-1 and Tier-2 (ex-Persistent) companies stayed elevated at ~20.1% and ~15.4% despite weak topline growth, as the net headcount addition declined (~14k QoQ) for the sixth-straight quarter (majorly Tier-1) coupled with lower sub-contracting usage giving further strengths to margins. Providers are experiencing weaknesses in discretionary spending, deferrals of transformation projects, and heightened scrutiny, resulting in delays in execution and constraints on hiring.

The deal TCV for Tier-1+Tier-2 companies during the quarter was strong at ~USD27bn (up +33% QoQ), (ex-TCS, Coforge) and the growth at +10.4% QoQ. Tier-1 (ex-TCS) outperformed the Tier-2 (ex-Coforge) companies with 13.4% QoQ growth in deal TCV, while Tier-2 (ex-Coforge) reported a decline of ~16% QoQ. Median Book-to-Bill (BTB) remains elevated at 1.2x for the sector, however the revenue conversion remains a challenge. The spending reprioritization to core areas and broad-based cost-takeout theme continued through Q4, while project ramp-down or deal cancellations have been more pronounced for few companies at the onset of macro uncertainties.

Other Key Findings from The Report

Leaders and Laggards: Within Tier-1, TCS has relatively outperformed the peers and reported +1.1% QoQ CC revenue growth, while HCLT reported +0.3% QoQ CC (+4.0% CC QoQ for IT Services) over a high base in Q3 (+6.0% QoQ CC). On the other side, Infosys has been the outlier and reported another quarter of decline at 2.2% CC QoQ vs a decline of 1.0% CC reported in 3Q.

Companies doubling down on margins: The demand environment remains unchanged in 4Q with large global enterprises continue to stay cost-focused and reprioritize areas of investments that are critical to their core operations and that can drive immediate ROI

Views on Valuation: The report maintains Prabhudas Lilladher’s stance to remain selective on the Tier-1 names that are carrying diversified business mix, and having built strong ability to capture the current enterprise spends. Additionally, with median payout yield of 3.7%/4.1% YoY in FY25e/FY26e, makes Tier-1 even more attractive.