High margins can not last for long in IT (Information Technology)

The better-than – expected profitability increases of Indian software services firms in the September quarter led to cost-saving initiatives during the pandemic, and most of these benefits may fade in the coming months, analysts said.

A year ago , Net revenue grew 4.33 percent , while adjusted net profit increased by 7.63 percent and the operating profit margin climbed to 27.10. Net revenue rose 4.31 percent for the top-five IT firms, while adjusted net profit increased 7.68 percent in July-September.

According to Kawaljeet Saluja and Sathishkumar S., analysts at Kotak Institutional Equities, only a small part of the earnings before interest and tax (EBIT) margin expansion posted by most companies in Q2 is sustainable. The benefits of many of the saved expenses, such as transport, cost of equipment, lower sales and marketing and deferred pay adjustments, would diminish with time. The rate of usage can vary greatly and may not be a sustainable lever for the margin.

For example , Infosys Ltd , which recorded record contract wins in the September period, predicted constant currency sales growth of 2-3 percent for FY21, suggesting moderate growth in the six months to 31 March. For now, a 23-24 percent Ebit margin band should not be deemed sustainable; this would have to be watched closely.

We believe some of the margin tailwinds are not sustainable, and their benefits would wane out partially as travel comes back and the attrition and offshore ratio normalizes,” analysts at Motilal Oswal said.

Many mid-tier IT firms, including large-cap companies, are currently trading higher than the historical average, amid the pace of growth over the next few years.

Notice that due to the fast growth trajectory, transaction wins stability, solid balance sheet with superior return ratios, good free cash flow production and higher payout ratio, some quality mid-cap companies are trading on a par with Tata Consultancy Services Ltd.

We have an optimistic outlook on the market,’ said Sanjeev Hota, Head of Analysis, BNP Paribas Sharekhan.

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