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IT Services: 4QFY18 review – Steady quarter with good margin execution

Companies in IDFC’s IT services universe saw USD revenue growth of 3% QoQ and 10% YoY, supported by dollar weakness. Adjusted EBIT grew (in rupees) 6%/10% QoQ/YoY and adjusted PAT (in rupees) rose 5%/6% QoQ/YoY. EBIT growth is strong given 3.4% YoY appreciation in INR against the US Dollar. Mid caps outperformed large caps during the quarter with 18% YoY revenue growth and 49% YoY growth in reported PAT led by margin expansion . Europe remains a secular revenue growth driver for the sector with most companies growing 15%+ YoY. Companies continued to push efficiency, as headcount grew at mere 1% YoY, as utilization continued to move up. The sector growth reported clear overall improvement, but we note the outperformance seems more customer and/or portfolio centric. We believe the IT services sector is more cyclical and recent quarterly performance reflects some recovery and/or bottoming out of these factors. Our revised estimates factor in a weaker INR against the USD and we maintain our preference for Infosys/TCS/TechM within the large -caps.

Key findings from Q4FY18 results

Q4 aggregate performance largely in line: Our coverage on aggregate basis reported in line performance with Rev/Rs-EBIT/Rs-PAT registering 3%/6%/5% QoQ and 10%/10%/6% YoY growth. Despite 3.4% YoY appreciation in the INR, companies have managed margins well and our coverage EBIT margins rose 38bps QoQ/2bps YoY. Guidance weighed on large caps while mid caps such as Mindtree (MTCL)/Mphasis (MPHL) saw revenue and margin-led EBIT beat. Europe as a geography continued to outperform, while BFSI and retail revenue growth was mixed across companies.

Europe showed secular growth: IT services pack showed strong secular growth in Europe (+7% QoQ, 22% YoY), with some support from FX. USD depreciated 12% and 15% YoY against the GBP and EUR, respectively, during the quarter. We believe that Indian IT is seeing consistent market share gains in Europe, as the geography opens up spending with increased outsourcing. The US underperformed Europe in Q4 and grew 6.5% YoY. US Tier-I bank centric players (Infy/TCS) underperformed in Americas, and players such as TechM/MTCL/MPHL reported healthy 15.6%/17.6%/19.6% YoY growth in the US.

Headcount growth remained weak; utilization up across the board: Aggregate headcount of companies within our universe was up only 1% YoY. However, continued increase in utilization across the sector (200-400bps YoY) supported margins, despite stronger INR on a YoY basis. We saw net addition of 6,760 employees in Q4FY18 compared Q3FY18. While attrition was steady at TCS, the same inched up for Infosys, Wipro and HCLT. The Indian IT sector has been using utilization as a margin lever, but, with most companies now operating at 80%+ levels (except MTCL-74%), we believe the same may not be available as a margin lever, going forward.

Performance of key accounts: We think that growth acceleration visible in mid-caps is customer specific, and this was visible in strong Top-10 account performance for players. MTCL and MPHL reported 20%+ YoY growth in Top-10 accounts, while Infosys’ Top-10 (US Tier-1 bank heavy) grew only 3.8% YoY. Non Top-10 did well at an aggregate level at 9.5% YoY revenue growth with all companies except Wipro (client specific issues) reporting superior performance.