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Home  » Business » What to expect from the IT biggies

What to expect from the IT biggies

Last updated on: April 05, 2005 13:27 IST
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The bulls in the markets seem to be back on track in the last week, after a largely bearish sentiment prevailed in the past few trading sessions. The apprehension was mainly on account of a number of factors. These included broker margin calls, year-end adjustments, higher US rates, reflecting the possibility of FII money flowing out of the markets, high crude oil prices, which could impact corporate profitability and profit booking after the markets touched their lifetime highs.

Towards the end of last week's trade, the bulls firmly established themselves mainly on account of bottom fishing at bargain levels and expectations of good quarterly results from corporate India.

Software companies are among the first off the blocks to announce their results and this time is going to be no different. MphasiS BFL is scheduled to do so on April 11.

Most of the industry majors have been reporting healthy topline growth in the past few quarters. These include the top tier end-to-end service providers like Infosys, TCS and Wipro, as well as the niche players like Geometric Software and i-flex solutions.

A combination of a healthy increase in volumes, stability in billing rates and a steady move up the value chain has been the key contributor to this growth.

Software majors*: Leading the way…

(Rs m) 2QFY05 3QFY05 Change 9mFY04 9mFY05 Change
Sales 61,685 65,578 6.31% 126,553 181,444 43.4%
Expenditure 43,989 46,660 6.07% 93,654 129,527 38.3%
Operating profit (EBDITA) 17,696 18,919 6.91% 32,898 51,917 57.8%
Operating profit margin (%) 28.7% 28.8% 26.0% 28.6%
Other income 364 1,775 387.6% 2,713 2,718 0.2%
Depreciation 1176 1395 18.6% 3,118 3,612 15.8%
Profit before tax 16,869 19,275 14.3% 32,465 50,973 57.0%
Extraordinary items (2,087) 4 (100.2%) (89) (2,083) 2,240%
Tax 2,468 2,939 19.1% 4,788 7,666 60.1%
Profit after tax/(loss) 12,269 16,334 33.1% 27,622 41,109 48.8%
Net profit margin (%) 19.9% 24.9% 21.8% 22.7%
No. of shares 1,447.0 1,447.0 979.5 1,447.0
* These are the combined results of Infosys, TCS and Wipro for the respective periods

Despite depreciation of the dollar against the rupee this year, software companies have still managed to grow their revenues at a decent clip, aided slightly by hedging their receivables. However, margins have been impacted due to the rupee appreciation.

Also, increased hiring, particularly by the top rung companies, as well as higher employee costs on account of wage cost inflation has led to some impairment on the margin front.

This is expected to continue going forward and will increasingly put pressure on margins, as these companies rapidly scale up their operations for an anticipated increase in business.

Infosys: Employee pressure!

FY01 FY02 FY03 FY04 CAGR
No. of employees 9,831 10,738 15,356 25,634 38%
Employee costs (Rs m) 7,178 11,179 16,771 23,659 49%
% of revenues 37.8% 42.9% 46.5% 49.7%

Volumes have grown at a very healthy rate for software companies. There has been a slight economic recovery in the US market, increased acknowledgement of the offshore outsourcing model, tapping of new geographies like Europe and globally, an increasing need for becoming more efficient in a hyper-competitive global market. We believe that these factors will drive volume growth going forward and this will be the key driver of an increased topline.

Billing rates have largely remained stable, with a very slight variation either side. With software majors increasingly moving up the value chain into services like IT consulting, these high-end services are expected to contribute more significantly to revenues for the end-to-end service providers like Infosys and TCS.

The offshore part of revenues is also expected to increase going forward, as these companies start building capabilities in high-end services and are able to execute them at their locations around the globe. This will pare the margin pressure to some extent.

What to expect?

Software companies in general have shown impressive growth over the past few quarters, mainly due to impressive volume growth and the famed global delivery model. We expect this to continue going forward, as companies tap new business verticals, enter new geographies and diversify their product offerings. These are critical in order to provide more value and 'returns per IT rupee/dollar' to their clients.

We expect billing rates to remain stable with a very slight variation. However, margin pressure will continue due to increased movement up the value chain. In this quarter, we do not expect the rupee-dollar exchange rate to have much of an impact on margins since there was not much of depreciation of the dollar. In fact, the dollar actually finished higher at the end of the quarter than its levels at the beginning. But we believe that this was merely a technical pullback due to factors such as high inflation in the US and rising US interest rates.

Apart from these factors, increased hiring in order to ramp up operations will result in higher employee costs and wage inflation. This will have a negative impact on margins. Companies that move up the value chain faster and move a higher proportion of work offshore will keep margin pressure at bay.

Equitymaster.com is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.

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