Repeat business from existing clients is not coming easily and companies are still in the process of building digital capabilities
On one hand, repeat business from existing clients is not coming easily and, on the other hand, companies are still in the process of building digital capabilities, which is where future growth will come from. Investors will have to reconcile to a slower growth trajectory, which cannot justify the premium valuations. If companies wish to command premium valuations, they need to improve capital allocation such that RoEs (return on equity) improve.
Structurally, the sector's dollar revenue growth has been coming down and is expected to decline further this year. The top four IT companies in FY15 grew dollar revenues by 11 per cent against the 13 per cent growth they reported in FY14. Barclays expects dollar revenue growth to decline to 9 per cent in the current fiscal, driven by dollar strength and slowdown in the energy vertical. Gartner expects revenues to contract 0.6 per cent year-on-year to $942 billion in 2015. Nasscom too expects the industry's revenue growth to be 13 per cent in FY16 against the 16-18 per cent witnessed in FY11-12.
While currency headwinds impacted revenue growth to some extent, the slowdown in verticals like energy and telecom led to revenue growth declining 0.5 per cent sequentially in the March quarter. TCS took a hit during the quarter due to issues in the telecom, energy and insurance verticals.
Infosys witnessed severe pricing pressure, which hurt revenue growth. However, over 2015-18, deals worth $147 billion are coming up for renewal and Indian players can look at improving marketshare by participating in the rebids. The rebids would provide a revenue opportunity of $29 billion market for the top five players.
However, pressure on topline growth would continue for the sector as the dollar has appreciated 7 per cent against the euro, 3 per cent against the GBP and 5 per cent against the Australian dollar. Gartner expects dollar strength to impact global IT spend by 310 basis points in 2015. Operating margins of the sector has declined sharply over the last three quarters.
While most companies seem to believe they will be able to maintain margins, the June quarter may see some impact on margins due to wage hikes. Reliance Securities expects Infosys margins to be impacted in the June quarter due to wages and higher visa costs but is building in margin of 25.9 per cent for FY16-17. Though TCS expects to maintain margins within the 26-28 per cent band, analysts are building in margins closer to the lower end of the band for FY16-17. Tech Mahindra's margins would take longer to recover.
Photograph: Reuters