IT stocks had a dream run on the bourses since the growth of the industry from 2000 to 2010. The pace of growth in USD terms has dramatically slowed down to lower double digit levels or higher single digit levels for most of the large companies. Growth is however expected to continue albeit at a lower pace and margins are expected to remain under pressure for the companies as competition heats up further. IT large cap stocks will now trade as fundamentally strong, mature stocks rather than growth stocks and valuations are unlikely to move higher unless growth drivers appear on the horizon.
India is the world’s largest sourcing destination, accounting for approximately 52 % of the USD 124 billion to 130 billion market. The country’s cost competitiveness in providing IT services, which is approximately 3-4 times cheaper than the US, continues to be its unique selling proposition in the global out sourcing market.
The IT sector in India grew at a compound annual growth rate (CAGR) of 25 % over 2000-2013 and is estimated to expand at a CAGR of 9.5 % to USD 300 billion by 2020. Infosys, TCS, Wipro, Tech Mahindra and HCL Technologies continue to be the big beneficiaries of the IT outsourcing services all over the World. The contribution to revenues mainly comes from the US and Europe followed by Asia Pacific and Rest of the World.
Information Technology companies have always had the opportunity to grow at double digit growth rates in the time period between 2000 and 2010. The growth in the time period between 2010 and 2014 is an interesting case to be observed. Would the companies be able to sustain high double digit growth rates five years down the line? Would the competition intensify in the industry and have an impact on the margins for all the companies? Let us find out what the data suggests and what is the trend observed in the last 5 years for these companies.
Infosys, TCS, Wipro, HCL and Tech Mahindra had growth in revenues (USD terms) in the range of 15% to 31% in the year 2011 but the expected growth in the year 2015 is in the range of 7% to 16% for these companies. Infosys revenues growth has slowed down sharply from 26% in 2011 to 12% in 2014 and is expected to grow at a single digit rate of 7% in the year 2015 according to the guidance that is given by the company. TCS also shows growth slowing down from 29% in 2011 to 16% in 2014 with an expected growth of 15% in the year 2015. Wipro has also shown a sharp decline in growth from 19% in 2011 to 6% in the year 2014. Tech Mahindra has shown uneven growth pattern due to mergers and acquisitions by the company. HCL Technologies growth also shows slowdown from 31% in 2011 to 15% in 2014. Cognizant a listed player in the US in the IT industry has revenues from US, Europe and Rest of the World. Revenue growth has been above 30% in the year 2011 but has slowed down to 20% in the year 2012 and 2013. Revenue growth is expected to be in the range of 15% and 20% for the year 2014.
EBITDA Margins for the companies shows a flat trend for most of the companies in the time period 2010 to 2014. Infosys shows a decline in the EBITDA margins from 30% in 2010 to 24% in 2014. HCL Technologies bucks the trend with an increase in the EBITDA margins from 16% in 2010 to 24% in 2014. TCS and Wipro have been able to maintain their margins at the same level and Tech Mahindra shows slight decline from 24% in 2010 to 22% in 2014 with an expected 20% in the year 2015. Cognizant has shown steady EBITDA margins from the year 2011 to 2013. The point to note here is that most of the companies have not been able to grow their margins as the revenues have grown which tells us about the intensifying competition between them.
Employee addition clearly indicates a slowdown in the hiring activity by the companies from the year 2010 to 2014. All the companies have witnessed slowdown in hiring with growth in the net addition of employees coming down from a high of 24% in 2011 to a low of 0.17% in 2014. Infosys has reduced the pace of hiring from 15% growth in the net addition of employees in 2011 to only 2% growth in 2014. Wipro has shown a sharp decline in the hiring activity from 13% growth in the net addition of employees in 2011 to an almost marginal growth of 0.17% in 2014. HCL also follows the trend with slowdown in the hiring activity with a growth of 19% in 2011 to 5% in 2014. Cognizant has shown a sharp decline in the net addition of employees from 32% in the year 2011 to only 9% in 2013. Hiring has certainly shown a sharp downward trend and indicates slowdown in the employment of intellectual capital for the outsourcing business for all the companies.
Apart from a slowdown in the hiring activity some companies have resorted to employee restructuring (a polite word for layoffs) where senior employees have been laid off and freshers are being hired for the job. Senior employees with fat pay packages and underperformance in the last two years have been laid off and freshers with low salaries are getting employed. This move corresponds to a major cost restructuring exercise for the companies. IT companies spend in the range of 60% to 65% for employee costs and layoffs amount to sizeable reduction in costs for the companies. They are then able to maintain their margins on a year on year basis even though business growth slows down in that time frame.
Geographic Revenue Trend
The data shows revenue contribution from the US coming down gradually for most of the companies. Revenue contribution has shown a rising trend for most of the companies from the Rest of the World and Europe.
Infosys has shown a decline in the revenue contribution from the US region from 66.1% in 2010 to 60.7% in 2014. Europe has seen a marginal gain in the revenue contribution from 22.5% in 2010 to 24.4% in 2014. Rest of the World shows a gain from 11.4% in 2010 to 14.9% in 2014.
TCS has shown a decline in the revenue contribution from the US region from 57.5% in 2010 to 55.3% in 2014. Europe has seen a marginal gain in the revenue contribution from 26.7% in 2010 to 28.7% in 2014. Rest of the World shows stable contribution at 16 in 2010 and 2014.
Wipro has shown a decline in the revenue contribution from the US region from 57.9% in 2010 to 49.8% in 2014. Europe has seen a gain in the revenue contribution from 26.2% in 2010 to 29.4% in 2014. Rest of the World shows a gain from 15.9% in 2010 to 20.8% in 2014.
Tech Mahindra has shown a gain in the revenue contribution from the US region from 29% in 2010 to 45% in 2014. Europe has seen a decline in the revenue contribution from 59% in 2010 to 32% in 2014. Rest of the World shows a gain from 12% in 2010 to 23% in 2014. The main contribution of revenues from Europe comes from British Telecom for the company.
HCL Technologies has shown a decline in the revenue contribution from the US region from 59.3% in 2010 to 55.9% in 2014. Europe has seen a gain in the revenue contribution from 27.3% in 2010 to 31.6% in 2014. Rest of the World shows a marginal decline from 13.4% in 2010 to 12.5% in 2014.
Slowdown in the US and Europe has led to marginal gains in revenue contribution from Rest of the World for the IT companies. The companies seem to be exploring other countries other than the US and Europe as a need of diversification. Contribution from the US has also slowed down as business has not grown from the region like it did in the period from 2000 to 2010.
International Monetary Fund (IMF) has cut its global growth projection for 2015 to 3.5% and for 2016 to 3.7%, downward revisions of 0.3% relative to its October 2014 forecast. The revisions reflect a reassessment of prospects in China, Russia, the Euro Area and Japan as well as weaker activity in some major oil exporters because of the sharp drop in oil prices. The US is the only major economy for which growth projections have been raised to 3.6% from 3.1% relative to the October 2014 forecast.