Margins of mid IT firms set to take a hit

Easing Total Contract Value

- Expenses are rising, will impact Q3

- Further, skill-specific cost escalating

- Tier-1 IT cos are better placed to absorb supply-side pressure

- But it'll impact tier-II firms more

Supply-side pressures in conjunction with impending cost headwinds like travel and office resumption should translate into largely lower than pre-Covid margins

-Sudheer Guntupalli and Heenal Gada of ICICI Securities

Bengaluru: Mid-tier IT services companies in India continue to report stellar performance as the second quarter performance indicates good traction in revenues. But supply side issues in terms of attrition have started to negatively impact the margin levels of these mid-tier companies.

Industry experts are of the opinion that hyper demand environment is tapering up and growth is likely to come down to pre-pandemic level from the next fiscal year for most mid-tier IT services companies.

In the second quarter ended September, L&T Infotech posted 8.9 per cent growth in revenues in constant currency term over the preceding quarter. For Mindtree, revenue in dollar terms grew 12.8 per cent for the quarter, making it the best quarter for the company in a decade. Similarly, Coforge dollar revenues increased 6.5 per cent quarter-on-quarter. For another mid-tier IT services firm L&T Technology Services, revenues in constant currency term rose 5.7 per cent in the second quarter. Both Coforge and L&T Technology Services have increased their revenue growth guidance for the current fiscal year on the back of strong deal pipeline.

However, experts said the growth will gradually normalise as the total contract value (TCV) of many tier-II companies have fallen in the second quarter.

"We expect growth rate of the industry to revert to pre-Covid levels as the base effect normalises and one-off distortions (for example- retail unlock boost in Mindtree) cease in the post-Covid equilibrium. Supply-side pressures in conjunction with impending cost headwinds like travel and office resumption should translate into largely lower than pre-Covid margins," said Sudheer Guntupalli and Heenal Gada of ICICI Securities in a note.

During the second quarter, margins of many of these mid-tier firms expanded on sequential basis, the growth to margins are running high as companies are looking at calling back employees to offices. Also, travel in many geographies has resumed, which is likely to raise expenses for these companies in the coming quarter.

"While skill-specific cost has increased in the market, we expect companies to try to right size their pyramids in order to offset the increase. Tier-1 IT companies are better placed to absorb supply pressures (than tier-II firms), given their capabilities with regard to training employees in newer skills," analysts at Motilal Oswal Financial Services Ltd (MOFSL) said in a report.

As a secular trend, all mid-tier companies have reported higher attrition ration as compared to preceding quarter. Though this is a similar trend in line with large peers, the backfilling expenses for tier-II companies is likely to remain elevated as compared to their large peers.