Indian IT services is among the few sectors that investors are betting on to weather the Covid-19 storm.

When the pandemic forced the country to go under lockdown in March, Indian information technology companies were quick to move their employees to a work-from-home routine.

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By the first week of April, the S&P BSE IT Index had lost nearly 26 per cent of its value from its peak in early January. This created a lot of buying opportunities for investors as stock prices tanked. As the revenue picture became clearer, some of the stocks started recovering. Since April, the index has risen nearly 55 per cent to over 18,000.

Due to the strong run of stock prices in the past few months, companies like Tata Consultancy Services (TCS), Infosys, L&T Infotech and Mindtree are trading above their three-year average PE ratios. TCS is trading at a 12-month trailing PE ratio of 27.4 times (vs three-year average of 24.2 times). Infosys is trading at a 12-month trailing PE ratio of 24 times (three-year average of 18.5 times). L&T Infotech (26.7 times) and Mindtree (23.9 times) are also trading well above their three-year average price earnings multiples.

However, Wipro is trading at a 12-month trailing PE ratio of 16.8 times, almost at its three-year average PE ratio. Similarly, HCL Technologies is also trading at a 12-month trailing PE ratio of 15.6 times, near its three-year average.

The fact that many companies had suspended revenue and margin guidance meant that the future revenue trajectory was fuzzy. Some companies such as Infosys and HCL Tech have reinstated revenue and margin guidance.

TCS, which normally does not give any guidance, said its revenues for the October-December 2020 quarter and the January-March 2021 quarter will be the same as that in the corresponding quarters in FY2019-20.

Predicting future revenues when there are many unknowns affecting clients’ businesses is difficult for IT services companies. However, we looked closely at the impact of the pandemic on specific verticals or service lines in the April-June 2020 quarter to find some clues on how the future will be for these companies.




Revenue growth pangs


One vertical that was severely impacted in the June 2020 quarter across most IT services companies was manufacturing. The lockdowns in many countries resulted in tepid manufacturing activity. As a result, clients have been curtailing their spends on IT services.

While revenues from manufacturing clients make up less than 10 per cent of revenues of TCS, Wipro and Infosys, it make up 16-20 per cent of revenues for Tech Mahindra, HCL Tech and L&T Infotech. The impact on revenues due to either muted manufacturing or delay in return to normal manufacturing activity, as recorded before the pandemic, will likely impact HCL Tech and Tech Mahindra more than the other tier-I IT services players.

On a quarter-on-quarter basis, revenues in dollar terms in the June 2020 quarter from manufacturing have fallen for TCS (-10.8 per cent), Infosys (-8.2 per cent), HCL Tech (-18.8 per cent), Tech Mahindra (-11.1 per cent), Wipro (-8.5 per cent) and L&T Infotech (-16.5 per cent).

Retail, consumer goods

Another vertical where there is pressure on revenues is retail and consumer goods. Retailers suffered revenue losses, and some are even going bankrupt across the US and Europe. The point to note here is that revenues from retail clients had already been under pressure for a couple of quarters. According to business analytics platform CB Insights, since 2015, 113 large retail chains have gone bankrupt, such as Neiman Marcus, JCPenney, MUJI and ALDO.

The pandemic has led to some clients (even new ones) adopting digital services, including cloud and cyber-security services. The weakness in this vertical has been persistent and is not a new phenomenon.

The only unscathed client group in retail is the companies supplying grocery and staples.

What is new is that the drop in international travel has caused IT spends by companies in the airline, travel, and hospitality businesses to shrink. Only a pick-up in international travel can lead to any meaningful rise in revenues from travel and hospitality clients.

Mindtree saw its travel and hospitality revenues halve in the June quarter. Till the quarter ended March 31, 2020, the company used to earn nearly 16 per cent of its revenues from travel and hospitality clients.

Revenues from retail and consumer goods have fallen (in dollar terms sequentially) across the board for top-tier companies such as TCS (-15.5 per cent), Infosys (-9.9 per cent), HCL Tech (-9 per cent), Wipro (-9.6 per cent) and Tech Mahindra (-6.2 per cent). These companies usually earn 10-16 per cent of their revenues from this vertical.


The banking, financial services and insurance (BFSI) industry that typically accounts for 20-30 per cent of the revenues of the top-tier IT services companies is a mixed bag.

Weakness in stock markets and mergers and acquisitions over the past year had seen the spend from capital market clients slowing. Record-low interest rates in the US and Europe meant that banks were not making much money and, as a result, were holding back on discretionary spends. All these factors played out in the earlier quarters. Companies such as TCS, Infosys, HCL Tech, Wipro, Tech Mahindra, and L&T Infotech have seen tepid sequential revenue growth since the quarter ended December 31, 2019.

There was an expectation among investors that in the quarter ended June 30, 2020, BFSI clients would be hit, especially banks.

The large fiscal and monetary stimulus in the US and Europe largely staved off bankruptcies across the board. But it can cause trouble in the latter part of FY21 or even FY22.

In the quarter ended June 30, 2020, the impact of the fiscal and monetary stimulus in the US seems to have stemmed any large cuts in expenditure by banking clients. The TCS management had pointed this out in their quarterly earnings conference call.

L&T Infotech’s management had said that although the going seems to be good for its banking and financial services vertical, future defaults on home mortgages could upset the apple cart.

But there is no telling whether this will materialise, or even if it does, its exact timing.

The positive impact of the stimulus in the US and Europe led to a lower drop in revenues (quarter-on-quarter) of TCS (-2.1 per cent), Infosys (-1.8 per cent), HCL Tech (-1.7 per cent), Tech Mahindra (-4.4 per cent) and L&T Infotech (-4.2 per cent drop in BFS and -2.7 per cent in insurance). Mindtree, however, took a bigger sequential hit of 9.5 per cent on its BFSI revenues in the quarter ended June 30, 2020.

Life sciences and healthcare

It is not all gloom and doom though. One of the verticals that saw some decent growth in the quarter ended June 30, 2020, for some IT services companies like TCS (up 1.4 per cent q-o-q), Infosys (2.2 per cent q-o-q) and HCL Tech (1.9 per cent q-o-q) was life sciences and healthcare.

It is not clear whether this was due to increased drug trials being conducted during the quarter, and whether this will be sustainable in the future quarters.

But the segment helped cushion some of the blow to revenues during the quarter.

Almost all IT services companies are seeing increasing demand from clients for digital, cloud, artificial intelligence and cyber-security services. Some of this has been due to the need for many businesses to adapt to a world where their customers are under lockdown and the need for social distancing.

This has led to some handsome deal wins despite the pandemic marring the revenue performance. TCS bagged deals worth $6.9 billion, while Infosys signed large deals worth $1.75 billion during the quarter ended June 30, 2020.

HCL Tech did not reveal the amount of deals that it bagged in the quarter ended June 30, but the management said it was higher than that in the same period last year.

Also, companies said that most of the hit to the revenues due to the pandemic were witnessed in the quarter ended June 30, and that they should return to growth in revenues from the quarter ending September 30.

How this plays out over the next few quarters will have to be seen considering the economic downturn across the world.



Cost control

Due to the pandemic, most IT services companies have implemented strict cost-control measures across the board. Apart from Wipro, which saw a 5.3 per cent q-o-q rise in employee benefit costs due to higher variable pay, companies such as TCS, Wipro and HCL Tech either saw employee costs fall or remain flat quarter-on-quarter.

Most IT services firms suspended pay hikes for 2020-21 when they announced their earnings for the quarter ended March 31, 2020.

There has also be a fall in travel and visa-related costs for most companies because of the ban on international travel from India. Most companies are also emphasising on cutting discretionary expenses.

There was also a significant sequential fall in attrition in the June quarter for HCL Tech (14.6 per cent vs 16.3 per cent in the March quarter), TCS (11.1 per cent vs 12.1 per cent), Infosys (11.7 per cent vs 15.3 per cent), Wipro (13 per cent vs 14.7 per cent) and Tech Mahindra (17 per cent vs 19 per cent), among others.

All these factors led to stable margins for most companies during the June quarter. Infosys (22.7 per cent vs 21.1 per cent), HCL Tech (20.5 per cent vs 20.9 per cent), Wipro (19.0 per cent vs 18.1 per cent) and LTI (17.4 per cent vs 16.7 per cent) saw margins remain steady or fall slightly. TCS (23.6 per cent vs 25.1 per cent) and Tech Mahindra (10.1 per cent vs 11.6 per cent) saw margins fall 150 bps.

Most companies’ management feel that when the pandemic recedes, costs will not increase as they will seek to make some of these cost savings permanent. This bodes well for margin accretion when revenue growth returns.

Into the unknown unknown

The Indian IT services industry is entering the ‘unknown unknown’ — a phrase coined by a former US politician to characterise events that might crop up in the future that one cannot predict or imagine. The commentary of Indian IT services companies’ top management suggests that these ‘unknown unknowns’ can work in two ways.

One, they could provide a significant revenue boost in the near term due to digital and cloud adoption by more companies. Two, they could lead to existing customers cutting their discretionary spends to conserve cash.

Clients have been asking for easier credit terms since March. Most companies have had to oblige because of their long-standing relationships with them. If the situation gets worse for some of these clients, future spends on technology will take off slowly, and also working capital cycles for IT services companies can get stretched. The fact that cost control and cash conservation is on the top of the mind of most companies’ managements suggest an uncertain future.

How things pan out from this fork in the road will depend on the agility of these companies. If the past performance is any barometer, Indian IT services firms have managed to weather most crises.

Stock picks

Those looking to invest in IT services companies, should stick to the big names. TCS, with its full suite of services, will provide stable dividend payout with a focus on maintaining margins in the longer term.

Infosys and HCL Tech are looking at faster revenue growth. Some of this might come at the cost of margins, but the fact that they expect to report margins of around 20 per cent in 2020-21, even if they see flat revenue growth in dollar terms, is a big plus.

L&T Infotech is an agile company that is looking to grow aggressively. It has grown above the industry growth rate in the past couple of years. A future merger with Mindtree will also add value to existing investors of LTI. These expectations have been baked into its current sky-high valuations.