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Credit FAQ: Why India IT Firms Can Shake Off The Downcycle

Our rated Indian IT companies have good defenses against downside risks. That's thanks to their strong balance sheets, high recurring cash flows, and history of good strategy execution. A low-cost workforce is an additional advantage.

Here we answer investor questions on why, even in economic downcycle and amid cost pressure, India IT players such as Infosys Ltd., HCL Technologies Ltd., and Wipro Ltd. can absorb IT spending cuts and potential declines in profitability .

Frequently Asked Questions

How does S&P Global Ratings envision the growth of India IT companies in the current downcycle?

We are positive. Large repeat business from essential IT services and high contract renewal rates bolster the operational stability of top India IT companies even in more challenging times. Long-term partnerships and good service delivery also mean customers face high costs to switch providers. The IT companies we rate also maintain diverse revenue sources across a range of customers, sectors and specific services.

This does not mean, however, the growth of these companies in the next 18 months is immune to global economic shocks. We expect revenue growth to slow over the next two years: from roughly 12%-18% in fiscal 2023 (ending March 2023) to about 5% through fiscal 2025.

This aligns with our GDP forecasts for the U.S. and Europe--two of the biggest markets for India IT companies. We forecast the U.S. to slow to 0.7% in 2023 and 1.2% in 2024, compared with 2.1% in 2022. We also expect Europe to slow to 0.3% in 2023 and 1.0% in 2024, from 3.5% in 2022.

Weaker macro conditions will likely cause customers to approach discretionary IT spending with more caution. Projects that can deliver quantifiable outcomes will be the priority. These may include cost-efficiency projects and vendor consolidation projects. Non-critical projects may be delayed or canceled. Migration to cloud will remain on customers' agenda because it is a crucial part of digitalization.

Chart 1


India IT companies have limited business and financial exposure to regional banks in the U.S. On the other hand, these IT companies have sizable exposure to the banking, financial services and insurance sector. Volatility in the banking industry and capital market will consequently test their performance in fiscal 2024.

What lessons do past downcycles offer?

Invest early in technology, remain competitive on costs, and ensure staff and customers are ready when opportunity arises. These are among the reasons why India's IT players have generated growth in downcycles and rebounded from crises.

Strong technological capabilities and timely investments in emerging technologies will allow Indian IT firms to seize on the recovery. Demand for digital transformation, automation and cloud adoption remains strong; and use cases of artificial intelligence, 5G, edge computing, and virtual reality continue to increase and could drive another wave of technological adoption.

The growth of IT players notably slowed during past downcycles (2007-2009 global financial crisis, 2019-2021 pandemic) as companies cut their discretionary spending. However, despite macroeconomic challenges, the revenue of India's IT players increased well above global GDP growth. Their ability to grow market share amid improving capabilities and cost competitiveness suggests greater resilience than their leading international counterpart, Accenture PLC.

Chart 2


Growth also rebounded quickly in 2010-2011 and 2021-2022 when market sentiment recovered. This stems from the release of suppressed demand for discretionary spending. COVID disruptions have also motivated investments by organizations to enhance worker and customer experience, and to better support hybrid work.

How do you explain the margin contraction in the India IT sector, and how will it evolve?

High spending to retain staff and ensure project delivery cut margins.

Employee costs contribute about 70% of the total operating costs for IT firms. In fiscal 2022 and 2023, the industry faced high attrition due to accelerated career moves post pandemic and supply-side challenges in skilled IT professionals in India.

Companies offered wage increases that were higher than normal and promotions to prevent the flight of skilled employees. They have also resorted to subcontractors to fill the talent gap, leading to a surge in related costs. As a result, EBITDA margin contracted by 1%-2% during fiscal 2022 and 2023, compared with pre-COVID fiscal 2019.

However, we still expect India IT companies to maintain higher margins than the industry average globally, given their access to the comparatively low-cost workforce in India. A meaningful margin recovery may only happen in fiscal 2025; this is slower than our previous expectation.

India IT companies face slower growth than they previously anticipated and may struggle in fiscal 2024 to improve their utilization rate of employees. Price negotiations with customers and transferring costs will also be increasingly difficult.

We estimate margin recovery of 1%-1.5% through fiscal 2025. Two factors support this. First, subcontracting costs and wage inflation are declining because attrition rates have stabilized since the first quarter of 2023. Second, IT companies have invested in training by allowing a high entry-level graduate intake in the past few quarters. This will widen the talent pool and lower employee costs per revenue for the next two years, given the lower costs of graduates.

Chart 3


How do you assess the financial positions and headroom of the India IT companies you rate, and their ability to maintain the ratings?

Rated India IT companies have strong financial profiles. They are in a net cash position, and continue to generate solid free operating cash flow. This provides financial headroom for acquisitions and share distributions.

Infosys has a history of operating at zero debt and making only bolt-on acquisitions. HCL Tech and Wipro made bigger acquisitions in fiscal 2020 and fiscal 2022; but they have balanced the impact of such acquisitions with lower shareholder distributions in the respective years.

Chart 4


India IT companies have clear shareholder distribution policies, which demonstrate how they use the cash they generate. The distribution policy of Infosys, for instance, links to free cash flows, providing the flexibility to balance distributions if acquisition opportunities arise. Wipro has signaled a more acquisitive strategy. It has indicated a lower percentage of shareholder returns than rival, HCL Tech.

Table 1

India IT players distribution policies
Distribution policy Achieve rate
Infosys Ltd. Approximately 85% of its free cash flow over a five-year period ending fiscal 2024 86% over the past four fiscal years
HCL Technologies Ltd. At least 75% of net income cumulatively over a five-year period ending fiscal 2026 88% over the past two fiscal years
Wipro Ltd. 45%-50% net income over a trailing three-year period 47% in the past three fiscal years
Sources: Company disclosures, S&P Global Ratings.

Our downgrade threshold for India IT companies considers both earnings quality and leverage. Considering they each have a net cash position of between US$2 billion and US$3 billion, there is adequate headroom. Barring very large acquisitions we see limited downside rating risk on leverage.

Large acquisitions of US$5 billion-US$10 billion tend to be rare. The two largest acquisitions in the past five years are Wipro's US$1.45 billion acquisition of the Capital Markets Co. (UK) Ltd. in fiscal 2022 and HCL Tech's US$1.7 billion acquisition of seven software products from International Business Machines Corp. (IBM) in fiscal 2020.

Table 2

Downgrade thresholds for rated India IT companies
Company Rating Debt-to-EBITDA – Fiscal 2023 actual EBITDA margin – Fiscal 2023 actual Downgrade threshold
Infosys Ltd. A/Stable/-- Net cash 24.9% Debt-to-EBITDA >1.5x sustainably; or EBITDA margin weaken substantially against our expectation
HCL Technologies Ltd. A-/Stable/-- Net cash 22.7% Debt-to-EBITDA >1.5x sustainably; or EBITDA margin below 20%; or slower revenue growth against our expectation
Wipro Ltd. A-/Stable/-- Net cash 19.6% Debt-to-EBITDA >1.5x sustainably; or EBITDA margin substantially below 20%
Sources: Company disclosures, S&P Global Ratings.

Our scenario analysis (see table below) indicates the financial headroom after a drop in EBITDA margins from the following influences:

  • revenue per employee--caused by pricing pressure and lower employee utilization as growth slows; and
  • employee cost per employee--caused by wage inflation.

Scenario 1: Assumes average employee costs increase by 2% more than our base case

Scenario 2: Assumes average revenue per employee decrease by 2% more than our base case; and average employee costs increase by 2% more than our base case.

The results show that even in the more pessimistic scenario India IT players have headroom to absorb profitability declines. Wipro has thinner headroom although for a downgrade the profitability would need to decline sustainably.

Table 3

Scenario analysis on India IT companies' rating headroom
Fiscal 2024e EBITDA margin Infosys Ltd. HCL Technologies Ltd. Wipro Ltd.
Base case About 24.5% About 23% About 20%
Scenario 1 About 23.5% 21.5%-22% About 18.5%
Scenario 2 22%-22.5% 20%-20.5% About 17%
Rating headroom Adequate Adequate Limited
e--Estimated. Source: S&P Global Ratings.
How do India IT companies compare against top-rated international IT services peers?

High margins and a stronger financial position support the high ratings on India IT companies compared with their international peers. This is despite their smaller operating scale.

The closest international peers for India IT companies include Accenture and Capgemini SE, which operate in both consulting and IT services. Both companies are well positioned in servicing digital transformation and cloud migration.

DXC Technology Co. and Kyndryl Holdings Inc. are also peers. However, each has a large legacy business that provides services in traditional managed infrastructure and information technology outsourcing.

Table 4

Rated India IT companies and peers
Rating Country Latest fiscal year revenue in mil. US$

Infosys Ltd.

A/Stable/-- India 18,212

HCL Technologies Ltd.

A-/Stable/-- India 12,586

Wipro Ltd.

A-/Stable/-- India 11,019

Accenture PLC

AA-/Stable/-- Ireland 61,594

Capgemini SE

BBB+/Stable/-- France 23,507

Atos SE

BB/Negative/-- France 12,121

Kyndryl Holdings Inc.

BBB-/Stable/A-3 U.S. 18,657*

DXC Technology Co.

BBB-/Stable/-- U.S. 16,265*
Note: Latest fiscal year for Infosys, HCL Tech, and Wipro ended in March 2023; Accenture in August 2022; Capgemini and Atos in December 2022; *Kyndryl numbers in December 2021; DXC in March 2022. Sources: Company disclosures, S&P Global Ratings.

Accenture is the clear leader in the peer group based on its size, margin profile, and next-generation expertise. The company strengthened its brand from its early pivot to digital capabilities through organic and inorganic means and has serviced more than three quarters of the Fortune Global 500 companies for nearly a decade.

Capgemini and India IT companies have achieved fast growth over the past three years by increasing digital transformation deals, enhancing digital capabilities, and establishing partnerships with third-party providers such as Amazon Web Services on cloud services.

The growth of Atos SE, DXC Technology Co. and Kyndryl Holdings Inc. has contracted in the past two years largely because their declining legacy businesses have been replaced by cloud migration.

Large international IT players have similar sizable exposure in U.S. and Europe. This is underpinned by the market size and large number of multinational companies in these two regions. In comparison, India IT companies have moderately higher exposure to the U.S. market. Capgemini and Atos, on the other hand, have an established footprint in the European market.

Chart 5


Infosys, HCL Tech, and Wipro have a cost advantage due to their access to low-cost workforce and growing working population in India. Reflecting this is their higher EBITDA margins against international peers that maintain a comparatively higher proportion of onshore resources. Accenture also achieved higher-than-industry margins given its large exposure to higher value workloads and below-industry rates of employee attrition.

Chart 6


Strong cash flow generation and low (or no) leverage underpin the high rating level of India IT companies compared with international peers. Accenture is also in a net cash position, with a record of maintaining such a position over the past decade. India IT firms and Accenture set clear policies to balance shareholder distributions, as well as acquisitions and capital expenditure (for internal research, development and employee reskilling) to improve their capabilities.

Capgemini has pursued aggressive debt-funded acquisitions over the years. However, it is also reducing its leverage as it gradually realizes earnings expansion from previous acquisitions.

Atos, Kyndryl, and DXC are investing more than 80% of their operating cash flows on infrastructure projects and on improving their capabilities in transforming their legacy business. These companies periodically make debt-funded acquisitions, resulting in higher leverage than peers.

In terms of governance, India IT companies are comparable with peers. They have a high level of investor disclosure, consistent messaging, and a management team with a strong execution track record. HCL Tech and Wipro have a high percentage of ownership by the families that founded them. However, we see limited influence of promoters on the companies' financial policies, especially shareholder distributions. HCL Tech and Wipro have fairly independent boards and professional management teams that limit such influence. Infosys has a diversified shareholding.

Chart 7


Chart 8


Why are your ratings on India IT companies above that on the sovereign?

Our ratings on India IT companies are not linked to the sovereign rating on India (BBB-/Stable/A-3). We believe the macroeconomic and geopolitical conditions of the key client markets have a greater influence.

India IT firms derive almost 60% of their revenues from one market, the U.S., the ratings on which are higher than that on India. They also generate 25%-30% of revenues from Europe. This approach is consistent across the industry. Accenture and Capgemini also have offshore delivery centers in India; and we do not link the ratings on these companies to the Indian sovereign.

Operating models have changed over the past decade, and reliance on India as the source of delivery has decreased. Protectionism has necessitated onsite investments and the hiring of local staff. As such, should India face stress, the operations of IT firms are unlikely to be as affected. New technology such as the cloud means companies are less bound to fixed delivery locations.

Moreover, even in the event of sovereign stress, India IT companies have low external financing needs to honor their offshore debt obligations, in our assessment. This stems from the sizable annual cash flow they generate from offshore operations, and the fact their offshore financial assets are sufficient to cover liabilities.

Editor: Lex Hall

This report does not constitute a rating action.

Primary Credit Analyst:Spencer Ng, Singapore +65 6597-6100;
Secondary Contacts:Shruti Zatakia, Singapore + 65 6216 1094;
Anshuman Bharati, Singapore +65 6216 1000;

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