The Indian IT industry has been passing through turbulent times for quite some time now. Fears of an impending recession have battered sentiment. Add to this the crisis at US and European banks, which is raising concerns over medium-term revenue visibility for technology companies. The banking, financial services and insurance (BFSI) vertical is a significant revenue generator for the IT industry. Hence, the scenario of low digital spend by BFSI customers is undesirable.
Against this backdrop, it is only natural for wary IT investors to keep looking for clues on what will happen next. IT giant Accenture’s earnings are often seen as an indicator of the performance of the Indian IT sector. Accenture, which follows a September to August financial year, announced its Q2FY23 earnings last week, which had its share of hits and misses. In constant currency terms, it reported 9% year-over-year (YoY) revenue growth, which was at the upper end of its 6-10% guidance range. Revenue growth during the quarter was led by its managed services segment. Note that Accenture competes with tier-1 IT firms in this segment.
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While second-quarter revenue growth exceeded expectations, Accenture trimmed its full-year constant currency revenue guidance to a range of 8-11% to 8-10%. This was despite stellar deal bookings during the quarter. Therefore, some analysts have warned that this could point to a slowdown in IT demand. Given the ongoing uncertainties in the financial sector, this guidance is likely to be revised further.
Accenture’s order book was in good shape. In fact, new bookings of $22.1 billion were the highest ever. As the accompanying chart shows, the managed services segment saw a strong year-over-year jump in bookings, although the consulting segment lagged behind. According to Accenture Management, demand for large transformation deals is on the rise, with a focus on modernization and cost removal deals.
The change in deal mix could mean an increased preference for Tier-1 IT firms over Tier-2, considering the former’s scale. “Accenture continues to indicate a slowdown in smaller, short-cycle orders, which we suspect are largely digital in nature. We believe this could have negative implications, especially for tier-2 players,” said analysts at Nirmal Bang Institutional Equities in a report dated March 24. Also remember, tier-2 tech firms Relatively expensive valuations have been a sore point for investors.
In an effort to reduce structural costs, Accenture expects to cut 19,000 workforce by FY24. Also, net hiring was at a multi-quarter low in Q2 and is expected to remain low in Q3. Analysts say Indian IT companies may face some margin erosion due to weak hiring and lower attrition trends.
Despite the positives in Accenture’s Q2 performance, meaningful turnaround for Indian IT stocks depends on several other factors. Therefore, investors should not be misled. “Simplified logic would suggest an extension of the strength in outsourcing growth and bookings from Accenture to Tier-1 IT,” said analysts at Ambit Capital Pvt Ltd. However, this should be viewed in the context of Accenture (managed services) outpacing Tier-1 IT for the last 14 quarters, added Ambit Report of March 24.
Meanwhile, the Nifty IT index has declined by 23.5% in the last one year. After such a massive correction, the once hot valuations of the sector have also cooled down. “We do not expect any negative surprises in Q4FY23 earnings of Indian IT companies. However, the pace at which IT stocks recover from here will also depend on developments relating to the US banking situation.”
