In the last 3-month period, the Indian IT sector gave 16 per cent handsome return, but that is still less than what the broader market gave at over 17 per cent. Despite the raging coronavirus outbreak in India and the world, equity investors have thrown caution to the wind. As each piece of the market started picking up pace, the IT sector’s allure moderated a bit. IT sector is a play on Indian exports, rupee depreciation, and the rising use of technology services by global companies. But as the US government raised the protectionism tempo, investors started getting cautious. Of course, IT sector stocks haven’t done badly as you can see for yourself. At this crucial juncture, earnings remain key for further upmove. One such indicator has been Accenture’s latest results. The encouraging numbers for Accenture bode well for Indian IT companies. Find out why experts are saying that.
Accenture’s 3QFY20 (its financial year ends in August) revenue growth of 1.3 per cent in local currency (LC) terms (YoY) is great as it captures the pain of April and May when client spending was probably at its worst. Tighter revenue growth guidance of 3.5%-4.5% in LC terms for FY20 versus 3-6% earlier includes a -3% to +1% range for 4QFY20. The revenue growth for the year includes nearly 200bps of inorganic contribution. This implies at its midpoint a -3% organic growth (YoY) for 4QFY20. The order booking at $11 billion, up 6% in LC terms is outstanding in the midst of what has been a global slowdown that has been far worse than the GFC of 2008-2009.
Accenture (ACN) also indicated that 4QFY20 order booking is likely to be good on a high base. This indicates a significant market share gain for Accenture in FY20, especially in the context of a likely high single digit decline in IT spending in 2020. “The revenue and order booking performance on such a large base are great in the context of what seems like a midsingle digit revenue decline in USD terms for the Tier-1 India heritage set. Only TCS and Cognizant in recent weeks have indicated that order booking momentum has been reasonable. Most other companies under our coverage and in our interactions, did not sound as positive,” points out Girish Pai, Head of Research, Nirmal Bang Institutional Equities.
At the upper end of Accenture's revenue guidance for 4QFY20, it would mean a pickup in growth vis-à-vis the worst months of April and May and at the lower end of the guidance it would mean flattish revenue. This broadly gels with commentary we have heard from TCS. While strategy and consulting revenue has been impacted (2% decline in LC), outsourcing held up (+5% in LC). This probably highlights the understated strength of ACN in legacy services, driven by its myWizard and SynOps automation platforms. ACN also stated that already won orders have not been impacted as knowledge transfer has been done remotely. We heard similar commentary from TCS too.
“While the ‘new’ at 70 per cent of revenues grew in high single digits, within that Accenture interactive saw growth moderation while cloud and security services saw robust growth. Customer experience related work and intelligent platform related work (likely work around SAP HANA and possibly even Salesforce.com) – 40% of revenue - seems to have been put on the backburner,” says Pai.
Positive and negative read-through
Stronger-than-expected results/commentary of Accenture sets an encouraging tone for the impending earnings season for Indian IT. This time, Accenture’s 3QFY20 comprising Mar-May’20 (MAM) is the most severely disrupted due to the Covid-19 pandemic. Despite this, the impressive performance and new deal bookings epitomize the resilience and adaptability of Accenture’s business model. Healthy growth in Italy (8% YoY, CC) bears testimony to this.
More relevant to Indian IT is the trend in outsourcing revenue, which grew 5% YoY (v/s overall growth of 1.3% YoY, CC). Even new bookings in the outsourcing segment witnessed strong increase (8% YoY, CC) with most sales and signings happening virtually. Management indicated that the pipeline for 4Q is very robust and should translate into robust bookings in the next quarter, says Motilal Oswal Research.
Despite the lockdowns and shift to Work from Home (WFH), drop in utilization (300bp QoQ to 88%) was not damaging. Operating margin expansion (220bp QoQ; 10bp YoY) should also calm the nerves of Indian IT investors on concerns around meaningful margin displacement due to factors like pricing pressure, etc.
“While most trends are positive takeaways for Indian IT, we are also cognizant of the fact that health and public services (12% YoY, CC) vertical was the biggest growth driver given the sharp increase in projects like the Covid-19 contact tracing apps, etc. It should be noted that healthcare vertical for Indian IT players (TCS – 8%, Infosys – 6%, Wipro – 13%, HCLT – 13%) is not as big as that of Accenture (18% of revenue). In addition, growth markets (20% of revenue) remained a key growth driver for Accenture, which again is not a big and reliable segment for Indian companies. Accordingly, we maintain a cautious stance on extrapolating the positivity in its entirety for Indian companies,” adds Motilal Oswal Research.
Even as Accenture management indicated that WFH is proving to be more efficient in some cases, they also hinted at some challenges in ER&D for people to collaborate. Analysts foresee similar roadblocks for Indian companies with high exposure to ER&D (e.g. HCLT, Wipro, LTTS, Cyient, etc.).
“We see Accenture’s results and commentary as a mere reiteration of the adaptability and resilience of the business model. This should partly alleviate the concerns of Indian IT investors around the potential disruption to operations, business continuity and new deal wins. Despite near-term uncertainties due to Covid-19 and the US Presidential elections, we continue to like Infosys/TCS/HCLT among Tier-I and LTI/Mindtree among Tier-II. This is attributable to their robust business models, high return ratios, strong management teams and reasonable valuations,” according to Motilal Oswal Research.
Accenture’s customers seem to be focused on shoring up what they already have as opposed to thinking about the next generation of customer experience, etc. However, this spending will eventually come back. One should see similar trends for Indian heritage players too. Accenture for the most part of the last decade managed to perform well due to its unique strengths despite being twice the size of TCS. This is due to (1) strong corporate IT spending in ‘new’ areas like Cloud, Security Services, Customer Experience and Digital Marketing (2) A revenue mix that has pivoted to ‘new’ services with ~70% coming from it (unlike ~40% for India-based players, even if one disregards classification problems). A lot of incremental growth for Accenture came from these areas, avoiding direct confrontation with price-competitive India-based players in outsourcing.
“We continue to see a limited read-through from Accenture’s Q3FY20 results as always... Growth was largely led by Health and Public Services verticals (+12% YoY local currency, an area with limited exposure for Indian techs) as growth moderated across other business segments. The positive surprise was around order bookings (+6% YoY local currency) with the company expecting strong traction here in Q4FY20,” says Manik Taneja, Senior Research Analyst, Emkay Global Financial Services.
However, Taneja sees risks in extrapolating Accenture's results to Indian firms. “We continue to see downside risks to growth for Indian techs in the near term, with a preference for Tier-I techs over Tier-II. Order of preference within Tier-I techs is HCLT > TechM (both Buy) > INFO > Wipro (Both Hold) > TCS (Sell). Sell rating on NITEC, MTCL and LTI. Our relative preference stays with BSOFT (Buy) and PSYS (Buy),” the Emkay analyst said.
The writer is a journalist with 14 years of experience