The latest Jefferies report casts doubt on the expected expansion in EBIT margins for IT companies in FY25. The consensus forecast is for an increase of 80 basis points year-on-year, to 20.3% for the sector. However, while there is optimism for a significant improvement of 380 basis points (240 basis points adjusted for one-time items) in… Tech Mahindra (NS:) (TechM), forecasts for other IT companies indicate a modest rise of 20 to 80 basis points. Jefferies highlights several challenges that could prevent these margins from expanding as expected, posing potential risks to earnings.
The report highlights a worrying trend in employee demographics at major IT companies such as Tata Consultancy Services (NS:) and Infosys (NS:). The share of employees under 30 years old fell to its lowest level in five years. This shift toward an older workforce, combined with near-peak utilization levels, indicates a less flexible and more expensive staffing structure. With demand remaining tepid, these companies may struggle to reverse the trend quickly. Therefore, a deteriorating employee hierarchy and high utilization rates can hamper margin growth.
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Jefferies points to a significant reduction in subcontracting costs across the sector. Currently, these costs are at their lowest levels since FY15, accounting for 9.1% of sales, down 230 basis points from their peak in FY22. This reduction reflects efforts by IT companies to reduce expenses amid declining demand. . However, with subcontracting already reduced to a minimum, there is little room for further cuts. Exceptions include Infosys and TechM, where subcontracting costs remain relatively higher but are still near five-year lows.
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The report also highlights valuation issues for giant companies like TCS. As per InvestingPro's fair value assessment, TCS is priced at INR 3,439 per share, while the current market price (CMP) is INR 3,893, indicating an overvaluation of 11.7%. This discrepancy poses a risk to investors, suggesting that the stock may be overvalued.
However, the use of fair value metrics, which adapt to market developments, can help investors make timely decisions. Once a stock's fair value exceeds the CMP, it may be wise for investors to consider profit booking and reallocate their investments to companies with more favorable valuation gaps.
Jefferies' analysis suggests that IT companies' expected margin expansions in FY25 may not materialize as expected. Factors such as an aging workforce, near-peak utilization, and already reduced subcontracting costs create significant barriers to margin improvement. Additionally, the valuation concerns raised by InvestingPro, especially for major players like TCS, add another layer of risk for investors. Staying informed through fair value assessments can help overcome these challenges and improve investment strategies.
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X (formerly Twitter) – Aayush Khanna
