The $100 billion information technology (IT) services sector will stage a strong recovery this fiscal, with revenue growth of 10-11%. The improvement will ride on increasing outsourcing and accelerating digital transformation services¹, accentuated by the pandemic, mainly in sectors such as banking, financial services and insurance (BFSI), healthcare, retail and manufacturing.

Higher business levels, and more profitable digital deals (~45% share in revenues in fiscal 2021, compared with ~40% in fiscal 2020) will also help IT services players maintain healthy operating margins. This, along with already healthy balance sheets will, in turn, lend a positive bias to the credit profiles of IT service providers.

A Crisil Ratings analysis of 18 firms, which account for ~70% of the IT service sector’s revenue, indicates as much.

Says Anuj Sethi, Senior Director, Crisil Ratings, “With customers focussing on optimising costs, outsourcing of IT services is seeing a steady rise globally. The pandemic has opened up additional opportunities in digital services due to surge in remote working, e-commerce and automated services. Ergo, deal wins by Indian players have expanded by 20% on-year in fiscal 2021, with ~80% of these being digital deals across verticals.”

The revenue growth in fiscal 2022 will be almost 400 basis points (bps) more than the growth of ~6% last fiscal and similar to ~10% growth logged over fiscals 2018-2020. That said, revenue growth across business verticals will vary.

BFSI, accounting for ~28% of IT service revenue, will clock 13-14% growth this fiscal (9% in fiscal 2021) due to rising share of digital transactions, continued regulatory compliance and data security.

Retail and manufacturing, which together account for ~30% of revenues, are expected to recover 8-9% after slowing down to 2-3% last fiscal. While the rising number of online retail transactions and client push towards digital marketing will drive growth in retail, manufacturing could witness some pent-up demand from improving industrial activity globally.

Healthcare, though a small segment accounting for ~6% of revenues, will sustain its high growth at 15-16%, benefitting from higher spending on tackling Covid-19 and increasing adoption of virtual services.

Other verticals (which contribute balance revenues) including oil & gas, communication, aerospace, defence and transportation will see modest growth of 4%, while travel & tourism will remain muted this year too, as global travel is not expected to improve significantly.

Despite stronger revenue growth, operating margins are unlikely to rise beyond the levels witnessed in fiscal 2021. Even with modest revenue growth of ~6%, operating margins expanded ~200 bps to a seven year high of 25% last fiscal, mainly due to cost savings from lower travel, favourable onshore-offshore mix (due to lower onsite roles following the pandemic), and lower attrition levels.

Says Rajeswari Karthigeyan, Associate Director, Crisil Ratings, “This fiscal, with gradual normalisation of businesses across the globe, a partial reversal of the cost savings logged last fiscal is likely. Also, with the expansionary recruitment phase, including maintenance of higher bench strength, employee costs (67% of revenues) are expected to rise. Nevertheless, players are likely to maintain operating margin at 24-25% this fiscal as well, supported by higher growth, increasing share of digital deals and benefits of continued automation.”

Crisil Ratings expects continued improvement in the credit quality of most IT firms, given their lowly leveraged balance sheets and robust liquidity. The sample set of 18 IT firms had an average gearing of ~0.13 time and cash surpluses of almost Rs 1.5 lakh crore at March 31, 2021.

While the global economy is expected to perform much better in 2021, the recurrence of additional waves of the Covid-19 pandemic in US and Europe, key destinations for IT services, would bear watching.

¹ Digital services are solution-oriented, value-accretive services which fundamentally changes the way a business operates or delivers value to its customers. Vendors harness cutting-edge technologies like artificial intelligence, cloud, internet of things etc. to deliver such services.