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Fitch Ratings expects TCS, HCL, and Wipro to retain their large net cash positions (Photo: Wikipedia)
Indian IT services companies are likely to see a modest rise in their profitability as their clients will continue to hold off on discretionary IT spending amidst economic uncertainties, according to the latest Fitch Ratings report. However, the clients will continue to spend on projects that focus on cost efficiencies.
The recently-released report added, “Fitch’s global economic outlook forecasts US real GDP growth to slow to 2.1 per cent in 2024 (2023: 2.5 per cent) and Eurozone real GDP to pick up to 0.8 per cent (2023: 0.5 per cent). We expect this economic backdrop will support revenue growth in the mid to high single digits, on a constant currency basis, for most Indian IT services companies in FY25. This is in line with their performance in FY24, but weaker than the historical average.”
Fitch Ratings report: Positives for IT services sector
The credit rating agency has said that the IT services sector’s long-term growth will be supported by client spending on digital transformation, cloud migration, and artificial intelligence (AI).
It added that Indian IT services companies have benefited from declining staff attrition rates in FY24, which has also reduced wage pressure. “The staff attrition rate for most Indian IT services companies peaked in FY22 at 22-24 per cent when the shortage of skilled IT staff led to increased competition for talent,” it said.
Additionally, Fitch believes that lower wage pressures, an increase in utilisation rates, and employing a higher proportion of fresh graduates will benefit profitability.
The report underlines that despite domestic and international competition, Indian IT services are unlikely to lose clients as customers typically do not change their IT services vendors based solely on cost considerations.
“The vendor is generally difficult to replace once it is entrenched into a customer’s software and internal systems. A new IT services vendor is also likely to face a significant learning curve when it replaces an existing vendor… Most IT services companies have not lost any key customers in recent years,” said the report.
It also said that demand volatility for IT services companies is stable relative to other technology sub-sectors.
Fitch Ratings report: Warnings for IT services sector
The report points out that IT services companies operate in a rapidly evolving sector, and therefore, the emergence of new technologies such as AI and machine learning can be disruptive to the companies’ position.
“The increasing use of cloud infrastructure, rather than owning servers, and the renting of software as a service, instead of buying software, could affect the growth of the Indian IT industry,” the report read.
It added, “The rising adoption of automated platforms remains a threat and this could dilute the labour cost arbitrage Indian IT services companies have over international peers. This could lead to a decline in profitability and a loss of market share.”
The report said that weaker client demand and increased competition could limit price increases in the sector. “Industry margins peaked during the early years of the Covid-19 pandemic as a result of declining employee attrition and lower travel and facility costs,” said the report while adding that the margins are likely to get stabilised now.
Fitch Ratings report: Projections for IT services sector
Indian IT services companies are likely to use most of their pre-dividend free cash flow for dividends or buybacks. “Other uses of cash could include small to mid-size acquisitions. Acquisitions will be funded by cash on balance sheet rather than incremental debt,” the Fitch report mentioned.
Fitch Ratings expects TCS, HCL, and Wipro to retain their large net cash positions. “Indian IT services companies are fairly well diversified, deriving revenue from various industries. However, the banking and financial services sectors represent the largest proportion of revenue for most of these companies. In terms of geography, IT services companies derive over 80% of their revenue from the US and Europe, with US-based customers contributing most of the revenue,” said the report.
It also noted that larger Indian IT services companies – like TCS, Wipro, and HCL – have robust liquidity with large net cash positions. “These companies have strong access to local and international banks as well as capital markets,” the report stated.
First Published: Aug 13 2024 | 4:52 PM IST
