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MOSL: TECHNOLOGY-The trend of gradually receding gross margins; Profitability a key near- term risk

TECHNOLOGY: The trend of gradually receding gross margins; Profitability a key near- term risk; Watch out for 1Q performance

 

• The trend of declining gross margins in IT Services…: Aggregate gross margins of Tier-I IT companies plunged by 370bp to 37.7% during FY14-19 from earlier 41.5%. Within Tier-II, aggregate gross margins declined by ~290bp, but the dip was not as uniform as seen in Tier-I companies due to bottom-up company-specific factors. TCS and INFY both contributed to the downward trend. While employee costs played truant in the case of TCS, sub-contractor expenses hurt INFY. Further, investments in Digital capabilities and pressure in traditional contracts too played a part in the declining gross margin trend.
• …while the margin levers have played their part: The INR’s 15% depreciation v/s the USD would have been offset by up to 40-50% by cross currency movements. But even adjusting for that, it would leave the companies with ~250bp of positive margin impact theoretically. TCS has often cited that the currency depreciation is incidental to the prevailing cost inflation of wages in India. And hence, that fact as a natural offset to the wage escalation should be inherently embedded in the model. Utilization rates too have increased across the board, visible in the few companies that continue to report the metric. The uptick in utilization is understandable, with feasibility for the same facilitated by declining growth rates over this period, which did away with the need for high bench strength seen in earlier years.