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BW Businessworld

Higher Tax, Wages To Dent Mid-Cap IT Profit

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Indian mid-cap IT companies are likely to see a modest revenue growth in April-June on stable demand, but most would see profits and margins squeezed by wage hikes and higher taxes.

The June quarter is typically stable for software services firms after a seasonally weak Jan-March, when clients finalise budgets for the next fiscal year, leading to a spurt in spending in the next two quarters.

"Tier-two IT companies are expected to report 2-6 percent volume growth," brokerage Prabhudas Lilladher said in a report. "We expect margin of tier-two Indian IT services companies to witness sharp erosion."

Companies could see margins slipping sequentially as most raised wages by an average of 12 per cent for offshore employees and about 2.5-3 percent for onshore employees.

Margins would drop 50-200 basis points on a sequential basis, said Angel Broking analyst Srishti Anand.

"For mid-tier companies across the board, we are seeing selling, general and administrative costs as a huge margin lever, so year-on-year if you go to see, margin movement for mid-tier companies would be upward."

A spurt in tax rates due to expiry of the Software Technology Parks of India (STPI) scheme will also hurt margins and crimp profits compared with a year ago.

Small and mid-cap IT firms would especially see a dent as many are yet to migrate to special economic zones to continue enjoying some sort of tax benefits.

Tax rates would rise to 25-27 percent from 12-16 percent earlier and the impact on profit margins would be huge, said Vimal Gohil, analyst, Asit C. Mehta Investment Intermediates.

"The increase in tax rates would have an additional 6-7 percent dent on profits," said Gohil.

STPI scheme was started in 1991 to boost software exports. Among other benefits, it provided a 10-year income tax exemption for units situated in software technology parks.

A Reuters poll of 16 brokerages estimates profits of Patni Computer Systems, MphasiS and Infotech Enterprises to continue to decline in double digits, while Mastek would stay in the red.

HCL Technologies and MindTree's profits are likely to rise in double digits, while profits at KPIT Cummins and Rolta India would inch up slightly.

Hexaware Technologies will, once again, see a more than three-fold rise, helped by strong enterprise resource planning business growth.

"Amongst mid-tier companies, we expect Hexaware to continue its good show as we build in flat margins quarter-on-quarter at 14.3 percent despite impact from salary revisions during the quarter," Emkay Global said in a report.

Hexaware's stock has shot up 25.3 percent so far this year, while the IT index has fallen 15.6 percent year-to-date.

Earlier this week, India's No. 2 software services exporter Infosys Ltd reported a lower-than-expected profit of 17.22 billion rupees, and warned it faces a volatile global economy.

The country's top IT services provier Tata Consultance Services, however, dispelled fears of a growth slowdown with its 28 percent increase in net profit.

"The inherent strength reflected in TCS' first-quarter earnings suggest that the weaker numbers reported by Infosys could be company-specific and related to the ongoing restructuring," UBS said in a report.

The National Association of Software & Services Companies (NASSCOM) has forecast software and services exports to increase 16-18 percent in FY12 due to robust demand for outsourcing from Western clients.