The landscape for IT services companies has become increasingly unpredictable, with revenue visibility dwindling amidst ongoing discretionary spending constraints. The expectation of a normalized growth trajectory in FY25 has been deferred, with companies issuing low single-digit growth guidance. The primary culprit behind this growth stagnation? Customer churn and leaky buckets in discretionary spending.
The leaky bucket problem persists, particularly among large-cap IT companies, exacerbated by macroeconomic uncertainties. With sizable client bases ranging from 1.5K to 2K clients and diversified vertical mixes spanning 7-8 industry verticals, these companies face numerous leaky buckets in their portfolios. This has led to subdued guidance, as Total Contract Value (TCV) is skewed towards long-duration deals focused on cost reduction, impacting short-term growth prospects.
Despite efforts to stimulate demand, discretionary spending remains lackluster. Clients continue to prioritize higher Return on Investment (ROI) projects and long-duration cost-saving initiatives, sidelining discretionary expenditures. Short-term projects have tapered off without immediate replacements, further exacerbating the growth slowdown.
Although IT companies report an uptick in TCV wins, a noticeable gap has emerged between Total TTM TCV growth and Year-on-Year Constant Currency (YoY CC) growth. This disparity is accentuated in the current weak macro environment, driven by increased client attrition, deal cancellations, and sluggish uptake of longer-duration contracts.
Bernstein has developed a churn model for leading IT firms like TCS (NS:TCS) and Infosys (NS:INFY) to forecast growth recovery trends. The model prioritizes factors such as large deal TCV for Infosys and the total order book for TCS. It anticipates churn to normalize by FY25 for Infosys, stabilizing at 2% of the previous quarter's revenue by FY26.
Amidst market volatility, large-cap IT firms offer better risk-reward ratios compared to mid-caps. TCS emerges as a defensive play due to its execution prowess and strong order book, positioning it for a robust FY25. Infosys, on the other hand, presents a cycle recovery opportunity but lags behind TCS in terms of discretionary spending visibility.
Revenue guidance for FY25 from Infosys and HCL Tech (NS:HCLT) fell below expectations, reflecting the impact of weak discretionary spending. Similarly, Accenture (NYSE:ACN) revised its guidance downwards due to reticence in discretionary spends and slower decision-making processes. Cognizant (NASDAQ:CTSH) and Capgemini also offered conservative growth forecasts for FY24.
The recovery cycle for IT services differs from past cycles, characterized by an elongated slowdown and slower rebound. Despite current challenges, there is no structural risk in the sector, with the US macroeconomic landscape stabilizing and the onset of a new technology cycle, particularly in Artificial Intelligence (AI), expected to drive demand.
The leaky bucket problem has been prominent in FY24, driven by macro uncertainties and client churn across various verticals. Industries like BFSI, Communications, and Hitech have been particularly affected, leading to delays in transformation programs and discretionary spending. However, companies like Infosys are adapting by focusing on vendor consolidation and AI-driven efficiency to weather the storm.
While IT services face short-term challenges, the sector remains resilient and primed for long-term growth, driven by technological advancements and evolving client needs. By navigating the leaky bucket challenge and prioritizing strategic initiatives, companies can emerge stronger and more agile in the face of uncertainty.
In case you are confused as to which IT stocks are good for your portfolio at the current market price, log into your InvestingPro account to see the fair value of stocks which is automatically calculated to ease the decision-making process.
Once you get to know whether the stock is undervalued or overvalued and by how much, it becomes a piece of cake to create and rebalance a winning portfolio. InvestingPro is currently available at a mouth-watering discount of up to 69%, for just INR 216/month. Click here to start making money in the stock market!
X (formerly, Twitter) - Aayush Khanna