Poor margins set to hit mid-tier IT companies

Mid-tier IT firms are struggling on account of intense pressure on margins, with rising wage bills, rupee appreciation and increasing attrition combining to hurt their fortunes over the last four quarters.

With attrition rate pegged at an average of 30% across the mid-cap segment, the cost of retaining employees has risen enormously. According to analysts, margins will continue to remain under pressure in the coming quarters.

?Most firms in the mid-tier segment have shown a margin decline during the December quarter. To fight attrition, some have announced mid-term salary hikes during the quarter in the range of 7-10%. Any meaningful margin expansion in FY12 seems unlikely,? said Sanjeev Hota, senior research analyst, Sharekhan.

According to a Sharekhan report, in the last four quarters, EBITDA margins of the eight mid-cap IT companies under their coverage declined owing to higher people related cost. Pune-based mid-tier firm KPIT Cummins Infosystems saw a dip in EBITDA margins during the December quarter as it slipped to 14.08% from 15.58% sequentially and from 21.28% a year ago. Infotech Enterprises recorded a 10 basis points quarter-on-quarter (q-o-q) dip in margins to 15.1% on the back of stronger rupee, said an Angel Broking note.

Banking and insurance software provider Polaris Software witnessed a fall in EBITDA margin mainly driven by rise in employee cost and currency appreciation. Margin slipped by 251 basis points to 13.1% from 15.6% q-o-q and from 16.2%, a year ago. For mid-tier IT services firm MindTree, margins were flat sequentially.

It posted EBITDA margins of 11.7% during the current quarter, compared to 19% a year ago. Persistent Systems? EBITDA margin also declined 159 basis points to 21.9% during third quarter from 23.5% in FY10. ?Among the mid-cap segment, NIIT Technologies and Eclerx showed strong margin improvement, while most companies showed a decline on a sequential basis,? said Sharekhan.

Going forward analysts are apprehensive on the profitability of the mid-cap segment owing to growing margin concerns. ?Except for a few mid-cap firms that cater to niche areas, revenue will be difficult to generate. With deal sizes getting bigger, it will get difficult to handle large deals as clients look for end-to-end solutions that mostly large companies can provide,? said Naushil Shah, IT analyst, Anand Rathi Financial Services.

?We will see further widening of valuation between large and mid-cap IT firms,? he added.

The October-December quarter, a period of holidays, is viewed as the weakest period for the IT industry as most mid-tier firms didn’t see much of robust volume growth. Rupee’s appreciation against the dollar also weighed heavy on the margins.

?For most of the mid-tier IT players we saw a marginal top-line growth during the quarter compared to the larger companies. The profit after tax (PAT) is also flat. Except for few players who caters to niche areas. KPIT Cummins Infosystems showed good performance because of its focus in the manufacturing sector, whereas Subex suffered as it caters to the telecom sector, which didn’t see much traction,? said Srishti Anand, IT analyst, Angel Broking.