ISG Q2 2022 Index Call: Macro impact visible in certain pockets

14 Jul 2022 , 11:46 AM

Sequential slowdown in contract activity off a tough base

Combined Annual Contract Value (ACV) in The America saw robust growth of 21% YoY in Q2CY22, led by strength in as-a-service ACV (+35% YoY). EMEA grew 17% YoY, as as-a-service ACV grew 25% YoY, while managed services grew 10% YoY. APAC saw sharp decline of 33% YoY in combined ACV. Managed services’ ACV grew by 2% YoY/1% QoQ in Q2CY22 on a tough base, as shift in demand from legacy infra business to ER&D and industry-specific BPO supported growth.

Key notables from the con-call

1) Demand environment for services remains healthy, with some evidence of a sequential slowdown, albeit on a tough base, due to on-going macro concerns.

2) Within managed services, strong demand for industry-specific BPO (+145% H1CY22 versus H1CY21), Engineering services (+41%) and ADM (+0.7%) is being seen, while legacy Infra services (-16%) is seeing a sizeable decline. Despite witnessing sustained demand, ISG lowered its growth forecast for 2022 for managed services ACV to 3.5% YoY (from 5.1%), largely on the back of a strengthening USD and macro risks from rising inflation and geopolitical concerns.

3) As-as-service ACV grew 13% YoY and declined 11% QoQ, as Chinese hyper scalers were affected by regulatory challenges and COVID lockdowns. Sequentially, USA/Europe remained robust. For 2022, ISG lowered its outlook to 18% YoY (from 22%) in as-a-services ACV.

4) Labor markets remain tight; however, attrition levels are beginning to stabilize on a quarterly annualized basis. Over 40% of the IT services workforce has been hired within the last 12 months across service providers.

5) Macro risks around rising interest rates, tight supply chain, fragile situation in Europe, COVID lockdowns, forex could impact technology budgets in 2023.

6) While some sequential slowdown in contracting activity was seen, ISG believes demand remains robust due to tailwinds from a secular demand cycle.

Indian IT growth rates likely to normalize from the high base of FY22

Analysts at IIFL Capital Services believe their recent cuts in revenue growth forecast bake-in key near-term risks highlighted by ISG, despite the structural digital transformation trends. They expect the Indian IT services sector USD revenue growth to slow down to 10% in FY24 (versus 19% in FY22), which is still above pre-COVID levels. Valuations based on P/E multiples are near pre-COVID levels. Hence, they have maintained a positive stance on the sector.

They prefer Infosys and Tech Mahindra (among large-caps) and Persistent Systems, Mindtree and Coforge (among mid-caps).