IT Sector Update - Deals trending higher - HDFC Securities

Mr. Apurva Prasad, Institutional Research Analyst, HDFC Securities and Mr. Amit Chandra, Institutional Research Analyst, HDFC Securities

We hosted ISG's 2QCY21 Index call and have outlined the key takeaways. ISG increased its growth outlook for CY21 (9/21% growth in managed services/XaaS as compared to 5/18% earlier), driven by (1) strong mid-sized deal momentum driving wins/pipeline, (2) ADM driving ITO deals, (3) strong growth in ER&D, and (4) stable pricing despite supply crunch. We reckon that greater propensity for outsourcing can be supported by a tight supply scenario and scope shifting to outsourcing. We maintain our positive view on the sector (IT Preview: Strong Momentum Continues) and our preferred picks are Infosys, HCL Tech, Mphasis and Sonata.

Key highlights:

Strong deal momentum: Both managed services (8% QoQ) and as-a-services (13% QoQ) clocked all-time high deal wins.

Mid-sized deals and Americas-led growth: Managed services growth was up 8/22% QoQ/YoY, driven by higher mid-sized deals, Americas' business (QoQ basis), ADM and ER&D services. Mid-sized deals uptick was witnessed in 2Q with 17% of awards were had an ACV between USD 20mn and USD 40mn.

Increase in growth outlook: CY21E ACV growth outlook increased by ~5% for managed services. Now, CY21E ACV growth in managed services and as-a-services is expected to be +9% and +21% (vs. 5% and 18% guided last quarter).

Call highlights:

Pipeline and deal wins: The pipeline continues to remain strong, driven by ADM contributing ~60% of the ITO deals. Four mega contracts were awarded during the quarter, of which two were in the US region and two in the EMEA region. ISG expects some mega deal closures in 3QCY21, which provides visibility for the coming quarters. 2Q deals had a higher component of new scope as compared to renewals (~70% new scope as compared to ~40% new scope earlier).

Pricing: Supply-side and talent crunch are not causing any pricing fluctuation, partly due to automation creating disconnect between labour cost and rates. At the same time, there is no pricing reduction for large deals. Providers are looking to hone talent in competitive areas with the prevalence of tiered pricing structure (based on skills and scope).

Engineering services: Engineering services has seen the highest deal volume in several quarters and ACV has grown 30%. The average deal ACV has increased to ~USD 15mn, led by IT/OT integration, digital twin, software development, and industry consolidation.

Talent and ESG: Investment by the enterprises on talent acquisition has accelerated and huge headcount addition is expected in the coming quarters by all the service providers. Diversity in vendor teams and scrutiny for ESG attributes are becoming important determinants for enterprise clients and it's getting incorporated into provider evaluation.

Source : Equity Bulls

Keywords