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Asia300

India's IT giants battle thinning margins as labor challenges mount

Looming American visa restrictions add to urgency of rethinking business models

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Tata Consultancy Services CEO Rajesh Gopinathan presents fiscal 2016 earnings.   © Reuters

MUMBAI -- Rising labor costs compressed profit margins at three major Indian information technology services companies in the year ended March 31 and are seen weighing more heavily this year as the U.S. mulls changes to its visa program for skilled workers.

The operating margin in Wipro's IT services business narrowed 2.2 percentage points to 18% in fiscal 2016, the company announced Tuesday -- the lowest on record in comparable data going back to fiscal 2009. While revenue and profit both climbed, Wipro is pushing back against declining profitability with urgency.

Efforts are underway to restructure Indian operations and will likely pay off starting in the July-September quarter, CEO Abidali Neemuchwala said at an earnings event. These changes are thought to include cutting several hundred domestic jobs.

Peers are not faring much better. Tata Consultancy Services' operating margin narrowed 0.8 point to 25.7%, the slimmest since the 23.7% of fiscal 2008. Infosys' margin was the thinnest in three years. Behind these dips are higher labor costs, coupled with slowing demand growth in the U.S. and Europe and sluggish overall sales.

Changing American visa rules look to intensify the blow. President Donald Trump ordered April 18 a review of screening procedures for H-1B visas, geared to workers with specialized technical skills. Exactly how screening may be tightened remains unclear, along with when the changes would take effect. But it has emerged that entry-level programmers of the sort that India's IT services firms tend to employ in the U.S. may be ineligible.

The visa situation "is something that affects the entire industry, and we have to live with that," Infosys CEO Vishal Sikka said in an April 13 earnings call. Each of the three leading IT services companies draws more than half its revenue from North America. They commonly send Indian engineers to the U.S. to handle software and system development for American businesses on a contract basis. Tighter visa requirements would narrow the pipeline, squeezing earnings.

Managing expectations

The trio have released downbeat forecasts for this fiscal year in light of these looming challenges. Infosys expects revenue growth to slow to between 6.5% and 8.5%. Wipro sees IT services revenue in the April-June quarter coming in on a par with or slightly below year-earlier figures and below what analysts have forecast.

Earnings growth at the three companies will start off slow in fiscal 2017, according to JM Financial. IDBI Capital Markets & Securities sees TCS logging revenue growth at the 7% level this fiscal year.

The stock market has taken in these gloomy prospects. Shares in TCS ended Tuesday down 10% from a recent high in mid-March. Infosys has dropped 11%, while Wipro is down 4%. This despite the benchmark BSE Sensex index reaching record heights.

TCS will respond to changes in North America, its largest market, by focusing on a less visa-dependent business model, CEO Rajesh Gopinathan has said. The company and its peers have also begun cutting back on new hires, with all three bringing on fewer people in fiscal 2016 than the year before on a net basis. Infosys' and Wipro's net additions dropped 65% and 42%, while the increase at TCS fell 2%.

The trio are on the hunt for new models of growth that can stand up to the current headwinds. Infosys went on an American acquisition spree in 2015. Wipro agreed in January to buy InfoSERVER, a Brazilian tech services company catering to the financial sector, for 27.6 million reais ($8.7 million). But the purchases have not accelerated overall growth so far. The storm battering India's IT sector will continue a while yet.

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