Excess IT spend is likely reversing leading to demand weakness

  • IANS
  • Stock Market News
Excess IT spend is likely reversing leading to demand weakness
Credit: © Reuters.

New Delhi, Aug 2 (IANS) Aggregate incremental revenues (QoQ) of top-5 IT Services players declined in 1QFY24 by USD 68mn, a first since 1QFY20, a report by JM Financial (NS: JMSH ) Institutional Securities said.Adjusting for higher working days (+3% QoQ), the decline was even steeper.

Top-5’s incremental revenues (QoQ) averaged USD 250mn/quarter pre-pandemic (1QFY19-3QFY20). This jumped to USD 620mn over 2QFY20-3QFY21 - after recouping dip of 4QFY20-1QFY21.

“We believe this excess IT spend was due to pushing forward a lot of future spend on digital transformation, catering to the immediate COVID-led demand. Given a typical 2-3 year project lifecycle, a lot of those projects might be coming to a close, in our view”, the report said.

“We therefore don’t see the current demand weakness as only a factor of uncertain macro. A weaker macro might only be precipitating the unwind, in our view”, it said.

“In a scenario where this Excess IT Spend is likely reversing, erosion of above-normal incremental revenues sitting in the current book of business could potentially wipe out the entire normalised incremental revenues over the next few quarters”, the report said.

The report said expectations were weak getting into 1Q. Results were weaker. Underlying trends were not very different than before. Shorter-term discretionary projects continue to be phased out/scaled down. Newer deals (of the efficiency types) are ramping slowly in comparison. In effect, clients are releasing more resources than deploying, resulting in net reduction in billed headcount.

These dynamics are now well understood. What is still not clear though is the rationale behind such client behaviour. Management commentaries suggest it is the uncertain macro.

“We believe it could also be due to the normalisation of “excess” IT spend during FY21-22. Incremental revenues of top-5 IT Service providers during 2QFY20-3QFY21 was 2.4x pre-pandemic levels. A lot of that “excess” IT spend was to cater to the immediate demand during pandemic”, the report said.

“We might now be witnessing unwinding of those spend/projects, precipitated by a tighter economic environment. If true, this hypothesis implies that the “old normal” incremental revenues could be potentially offset by the unwinding of equally large excess IT spend over the next few quarters. We therefore don’t foresee any back-ended growth pick-up in FY24 at this stage”, the report said.

“A weak FY24 exit could potentially put FY25 estimates at risk, in our view. We remain cautious”, the report said.

Large-cap IT Services players reported (4.2 per cent)-1.0 per cent QoQ cc growth in 1QFY24. Weakness has been concentrated in BFSI and Telecom. Incidentally, these verticals saw the highest “excess” IT spend post COVID. Manufacturing, which on the other hand saw lower excess IT spend, continues to be resilient. These trends corroborate our hypothesis, the report said.

(Sanjeev Sharma can be reached at Sanjeev.s@ians.in)



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