Trump Tremors in a Tame Quarter

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IT majors set to reveal muted third quarter growth, new visa norms could add to woes

Infosys, the country’s second largest software services exporter, will usher in the quarterly results season for the Indian IT majors on Friday. Even as the company’s board is gearing up for announces the financial results for the December quarter, the market has already arrived at a conclusion that not only Infosys but almost all Indian IT majors will be offering only a muted growth for the September-December quarter, generally considered a weak quarter by the industry.

Going forward, IT companies face a significant challenge from a new US Bill titled ‘Protect and Grow American Jobs Act’. The bill proposes to raise the pay of an H-1B visa holder to $100,000 from $60,000 now.

Fortunately, IT could be the only industry that may not blame the ‘demonetisation’ effect as the root cause for its expected low performance. However, it has enough issues to grappled with–from Trump and H1B Visa restrictions to automation–on a global scale.

Software industry body Nasscom had already cut the annual growth for this sector from a high of 10-12 per cent to a reasonable 8-10 per cent. IT analysts at several brokerage houses have more modest expectations for the industry this year.

“Waning growth, margin concerns and multiple guidance cuts by tech majors (Cognizant & Infosys) have tripped the Indian IT index by 8 per cent in the past one year. An unfortunate confluence of technology transition, worsening macros and sharp currency movements have taken a significant toll on growth,” feels Sandip Agarwal of Edelweiss

Securities.

An analysis by Edelweiss suggested key growth drivers for the industry–unleashing of pent up demand; improving US corporate profits and global DGP; increase in global sourcing and market share gains for Indian players; and digital and IoT wave-- which itself is a $2 trillion opportunity.

“While digital, IoT and shift of technology cost from direct to indirect are structural growth drivers, their impact will vary between players based on individual strengths and capabilities. Cognizant, Infosys and HCL Tech are ahead in their technical strengths and exposure to above drivers of growth, followed by TCS and Tech Mahindra. On the margin front, Infosys, Tech Mahindra and Wipro are envisaged to be key winners. Overall–in terms of revenue growth, margin and cash distribution–Edelweiss has ranked Infosys at the top, followed by Tech Mahindra and HCL Tech, respectively.

On its part, Reliance Securities expects the Indian IT firms to post a combined 0.2 per cent sequential rise in revenue in dollar terms for the 3Q. It expects the top-5 IT firms to post anywhere between a negative 1.3 per cent to a positive 2.4 per cent quarter-on-quarter revenue growth in dollar terms, with Tech Mahindra likely to lead, thanks to acquisitions.

According to it, this quarter will witness a key cross-currency headwind emanating from weakness of the British pound and euro, which have depreciated by 5.8 per cent and 3.6 per cent, respectively, against the greenback on a quarterly average basis. This is likely to cast an adverse impact on reported dollar revenue growth to the tune of 50-130 bps, with Wipro and HCL Tech likely to be affected the most. On the margin front, most IT firms are likely to witness a decline, barring Tech Mahindra among the top IT firms. TCS, Infosys, Wipro and HCL Tech will all see contraction in margin owing to factors like rupee appreciation against pound sterling and euro, wage hikes, lower acquisition margins and slow volume growth. However, it expects Tech Mahindra likely to report 122 basis points QoQ rise in earnings before interest and taxes (Ebit) margin on the back of one-time costs incurred in Q2.

Given the scenario, a lot will depend on the emerging IT budget trend in the new year. “However, it should be noted that in light of Donald Trump assuming the US presidency only by January 20, client organisations could take some time before finalising their IT budgets, which would lead to reduced visibility for IT firms,” Reliance Securities said, in its latest report.

On the other hand, a report from Kotak Institutional Equities highlights a weak revenue growth for tier-1 players since the usual end of the year furloughs and multiple factors that have dragged growth in H1FY17 will persist, especially weak financial services spending and captive shift and insourcing. In addition, it expects contract-specific factors to also have a bearing.

“We expect Infosys to report 0.3 per cent constant currency revenue decline and TCS to report 1.3 per cent constant currency revenue growth. Acquisitions and inorganic activity will aid numbers for HCL Tech, Wipro and Tech Mahindra,” it said. On Y-o-Y comparison, organic revenue growth across companies has drifted down to single digitals, but will steady out or improve moving into FY18, it said.

Emkay Global said it expects modest revenue growth for tier-I firms in a seasonally weak quarter, with sequential cross currency headwinds marring the reported revenue performance further. HCL Tech and TechM will lead on sequential revenue growth amongst tier-Is, it said.

“We believe that Investors need to be focused on the following aspects in the ensuing results–(1) initial trends on CY17 budgeting cycle (and more so in ‘financial services’, given relatively constructive commentary from a few US listed tier-II techs, and (2) potential implications on medium-term margins given high probability of tightening around H-1B visa rules under the new US presidential regime.”

An India Ratings and Research (Ind-Ra) report has said the margins of IT sector companies will come under further pressure in the event of the new US Bill titled ‘Protect and Grow American Jobs Act’ gets passed. The key proposal in the bill is to increase the salary of H1B visa holder to $100,000 from $60,000 per annum at present and the cessation of an exemption of having a master’s degree.

Ind-Ra has noted that the employee cost of IT companies has increased over the past eight quarters and has impacted margins negatively. The passage of the bill would impact IT companies operations and might lead to further increase in the onshore efforts and subcontracting expenses. Indian IT companies generate around 55-60 per cent of the revenue from the USA. The onsite proportion of revenue exceeds the offshore portion and the subcontracting expenses as a percentage of revenue has increased by 50-100 basis points over the last eight quarters for the top IT companies.

"Further the removal of the exemption of possessing a master's degree to qualify for a H1B visa if implemented will reduce the talent pool qualifying for such visas and in turn result in either increased employee cost for hiring employees with higher qualification or subcontract work, both of which would increase the cost of operations and pressure margins," Ind-Ra said.

According to a statement from Equirus, a fast emerging mid-market investment bank, on Wednesday, an internal analysis by it showed that increase in minimum pay, for all H-1B positions, to $100,000 per annum starting FY18E, could impact Infosys’ gross margins by 260 bps. With everything else remaining constant, the firm believes that it could impact its FY18 earnings per share by nine per cent.

govardand@mydigitalfc.com

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