India: A preferred ITO destination for application maintenance

MUMBAI, INDIA: India Ratings & Research (Ind-Ra) has maintained a stable outlook on IT service providers for FY15 to reflect their stable credit profile, low debt levels and cash-rich balance sheet.

Margins will remain under pressure due to wage inflation and potential rupee appreciation. However, better business conditions in Europe and North America will result in revenue growth for IT service providers in FY15.

Revenue growth for FY15 is likely to improve marginally from about 13 percent in FY14. The growth will be backed by an improving business environment and increased competitiveness of Indian exporters on the back of a depreciated rupee.

The flat to moderately positive budgets of clients, which are under pressure to reduce costs, will push them to opt for outsourcing commoditised services like application maintenance and other labour-based offerings to Indian IT companies.

For FY15, EBITDA margins are likely to remain under pressure due to wage inflation in 1QFY15. Ind-Ra expects the Indian rupee to appreciate to around 56-57/USD by end-March 2015, which will further depress EBITDA margins.

Margin erosion is expected to be partly off-set by a stable pricing environment and disciplined bidding to pare low-margin contracts. Higher employee use as well as improvements in productivity levels will also help contain margin erosion.

Liquidity is likely to be stable in FY15 on the back of large cash balances, low debt levels in balance sheets and no firm commitments on work-related capex or share buyback programmes in the near term.

Acquisitions by companies looking to enter into the mobile applications or cloud computing space could reduce the large cash balance as could large dividend pay-outs. However, the strong cash generation of IT companies will keep liquidity stable.

What could change the outlook?

Rupee Appreciation to Impact Margins: A significant rupee appreciation will have a negative impact on the margins of Indian IT companies and their outlook.

Event Risk: Large dividend pay-outs or share buybacks, debt-funded acquisitions, which pare liquidity or increase debt levels might have a negative impact on the ratings of individual IT companies. Adverse regulatory developments limiting the ability of the US or Europe-based companies to offshore/outsource contracts could also impact the sector's outlook negatively.