Stable rupee, visa woes hit IT firms' margins

Currency stability, rising attrition rates and ongoing supply crunch coupled with high visa rejection have hit gross margins of IT companies.

Aggregate gross margins of Tier I IT companies, which have annual revenue of over $4 billion, plunged 370 basis points to 37.7% during FY14-19 from the earlier 41.5%, Ashish Chopra, research analyst, Motilal Oswal Financial Services, said.

"Within Tier II, aggregate gross margins declined nearly 290 bps, but the dip was not as uniform as seen in Tier-I companies due to bottom-up company-specific factors. Tata Consultancy Services and Infosys both contributed to the downward trend. While employee costs played truant in the case of TCS, sub-contractor expenses hurt Infosys. Further, investments in digital capabilities and pressure in traditional contracts too played a part in the declining gross margin trend," Chopra said in a recent report.

The 15% depreciation of rupee against the US dollar would have been offset by up to 40-50% by cross currency movements, according to Chopra.

But even adjusting for that, it would leave the companies with about 250 bps 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, he said.

"The recent currency stability, rising attrition rates across the industry and ongoing supply crunch coupled with high visa rejection rates pose a threat to margin estimates for FY20," Chopra said.

The US is considering nearly 10-15% cap on H1 visas for selective nations, including India. The move would be on nations that restrain from global data storage norms, seeking foreign companies to store data locally.

According to him, Infosys is faced with headwinds from wage hikes, visa costs and also remnant investments in localisation, which collectively add up to 150-200 bps. A soft start at nearly 20% EBIT levels would imply full-year average near the lower end of 21-23% margin band. Currently, the first quarter estimate stands at 20.8% and the fiscal 2020 consensus estimate is 22.2%.

TCS, too, has said that wage hikes are nearly 200 bps headwind to margins (180 bps in Q1FY19). In the absence of significant pull-back from some levers, it may start the year close to about 24% (against Q1FY20 estimate of 24.4% and FY20 estimate of 25.5 %), Chopra said.

"Multiple Tier-II IT companies have cited that the going with respect to the supply dynamics has been toughening in recent quarters," he said.

Madhu Babu, IT analyst, Centrum Institutional Research said the first quarter will see wage hike challenge, and currency is also not favourable. There will be fresh visa applications in the first quarter as well. So Q1FY20 will be weak on a sequential basis.

"The Indian IT sector will see the confluence of both the factors, robust momentum in digital and tremendous pressure in traditional business. We expect Tier I IT vendors to deliver 5-10% organic constant currency growth in FY20E (growth rates to vary for each vendor). TCS would deliver the strongest growth in the sector while Wipro the least," Babu said.

According to him, TCS and Infosys are expected to deliver 10.4/9.8% organic US dollar revenue growth for this fiscal. TCS and Infosys would be growth leaders in the IT services sector among the Tier I IT vendor space.