TCS and InfosyS both reported earnings with two common factors, though Infosys was a bigger surprise compared to TCS. These factors include a decline in demand from North America, with some discretionary programmes being put on hold or cancelled, as well as challenges in flexing margin levers due to sticky near-term costs at the start of a slowdown. While we acknowledge the heightened headwinds that may affect multiples in the near term, our long-term perspective on margins and growth remains unchanged. Stocks to avoid are the ones trading at premium multiples after assuming elevated growth and margin assumptions. The slowdown was sharper than expected. Infosys and TCS reported q-o-q revenue declines of 3.8% and 0.8%, respectively, in North America. The revenue decline in North America was across verticals on a sequential basis. The reasons for the decline were a pause in discretionary programmes and even cancellations. After a slow start in January, projects were paused in February and it continued in March.
The banking crisis in US regional banks and European banks in March 2023 has induced greater caution and could impact the June quarter. Kotak expects FY24 to remain weak for IT firms.
However, the adoption of cloud-native applications to increase as more IT workloads move to the cloud. Workloads on the cloud are still 30-35% and will require additional two-three years to reach the desired 60-70% levels. There are plenty of exciting technologies, such as IoT, big data and deep learning AI, that lend themselves well to cloud environments. Analytics and big data on the cloud are already seeing massive adoption. These can sustain healthy growth for IT services beyond the cloud migration phase, it added. IT services companies have experienced broad-based growth over the last two years, driven by aggressive spending on digital transformation by enterprises. Although digital spending is expected to continue, a challenging business environment will also compel organisations to prioritise cost management.
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In response, companies may pursue cost optimisation measures, including opportunities related to cloud and SaaS consumption. TCS and Infosys are best positioned. HCLT and LTIM can benefit in select cases. Similar cost take-out opportunities, but among smaller enterprises may be addressable by a larger pool of companies. Many other companies will struggle—growth between leaders and laggards should widen in FY2024 and beyond.