The credit profile of Indian IT Services companies remains stable underpinned by its ability to sustain free cash flows despite pressure on revenue growth and margins.
With aggregate operating margins of ICRA sample set at 22.5% for FY2018 coupled with moderate capex (organic as well as inorganic) and working capital requirements, the free cash flows have remained robust historically.
Despite pressures on growth and margins over the medium term, these factors are unlikely to impact the free cash flow generation ability of Indian IT Services companies though there could be moderation in the quantum of such cash flows.
The credit profile is also supported by net cash position with significant liquidity in the form of surplus investments generated out of past cash flows. Our sample set (13 leading Indian companies) reported surplus liquidity (net of debt) of approximately Rs. 1,600 billion March 2018 despite healthy dividend pay-out of approximately 30% (Rs. 206 billion) in addition to share buybacks (Rs. 73 billion).
ICRA expects most large IT services companies to maintain high dividend pay outs and share buybacks, as there are limited avenues for fund deployment. The investment requirements (organic and inorganic) for Indian IT Services in the past have been moderate relative to internal cash flow generation. Majority of the acquisitions done by Indian IT Services players have been to acquire competencies rather than achieve scale and size.
The growth of Indian IT Services companies will be impacted by lower deal sizes in digital technologies, cloud adoption and high competitive intensity from local as well as international players. While companies have increased spending on digital technologies and awarding new contracts, the overall IT budgets have moderated leading to lower incremental spends. Indian IT Services companies are re-orienting their business models focusing more on high end services such as IT consulting & emerging technologies (digital) and have made considerable progress so far, though it currently lags international peers. ICRA expects FY2018-2021e CAGR to be around 9-12% for the Indian IT Services companies compared to CAGR of 17.1% experienced over the FY2013-2017 period.
Margins will be supported by factors such as ability to modify cost structure with rational and variable salaries couples with gradual reduction of high cost resources. Besides deployment of operating levers such as higher share of fixed price contracts, lesser idle resources & automation benefits will also help manage costs. However, these factors will provide limited cushion leading to overall decline in operating margins from 22.1% in FY2018 to 20.8% in FY2021e for ICRA sample companies (13 leading companies).