We expect the IT services sector to grow moderately and profitability to increase slightly in 2024

Translation: Original comment published in Finnish on 12/5/2023 at 6:41 am EET.

We expect the dual dynamics of the IT services market to continue next year and slow down growth. In our estimate, the demand environment will remain watchful and cautious next year. However, the trend of digitalization is not stopping and there are still areas of faster growth when the development of critical activities cannot be stopped. We expect profitability in the sector to improve slightly, driven by cost savings, but still stays below potential due to headwinds.

In 2024, we expect growth to remain moderate and clearly slower than in previous years

In 2024, we estimate that companies will continue to develop in different categories based on their different profiles. We expect the performance of companies with a profile in software development and a stronger private sector focus to remain relatively weaker next year (Siili, Vincit, Witted, Loihde). By contrast, we expect companies operating in the public sector and in the more traditional IT service areas to perform relatively better next year (Gofore, Innofactor, Digia, Tietoevry, Netum). For these companies, a clearly higher share of revenue is recurring or based on long-term contracts, which is true also for Digital Workforce. There is still considerable uncertainty about the market situation and customer demand, although some of the worst may already be behind Naturally, this means that there is still a lot of uncertainty in our forecasts.

As the competition has shifted from talent to customers, success in sales is critical for growth. Naturally, the companies that have invested in this in the past hold a strong position. On the other hand, the companies whose particular strength has been strong talent recruitment are now benefiting relatively less than before. We anticipate that managing billing rates will continue to be challenging due to market sensitivities and changes. In addition, we expect customer prices to remain under pressure in a highly competitive environment, although we estimate that the worst of the price competition is already behind. In the talent market, turnover will remain low and there is more talent available now than in years for those areas where sales are strong and customer demand is high. In our estimate, wage inflation will be more moderate than it has been for many years.

We expect organic growth in the IT services sector to remain moderate and acquisitions to slightly support growth. However, M&A activity has been record-low in 2023, so acquisitions will not provide much growth support. Part of the weaker growth is due to strong comparison figures in the first quarter. We forecast the median growth in revenue for the companies in our coverage to be 2% and the average 4%. We estimate the median and average of organic growth that we follow closely to be around 2%. We thus forecast growth to be significantly slower than in the previous 5 years (2023e: 2 % and 2018-2022: 8-16 %).

We expect profitability to improve slightly driven by cost savings

We expect the median EBITA margin of the companies in our coverage to improve slightly to 7.2% (2023e: 6.9 % and 2018-2022: 7.6 %). We estimate that profitability challenges will continue to arise from the difficulty of managing billing rates as projects are deferred and growth is moderate. In addition, pressure on customer prices, and therefore also wage inflation that is low in a historical context, is a headwind to profitability. Several companies have already issued profit warnings this year (7/11 companies), often followed by change negotiations to compensate for falling customer demand. Thus, cost structures will be put in shape in 2023 and, as the market improves, we could see profitability return to much better levels, at least temporarily.

Source: Companies and Inderes

A comprehensive summary of the IT services sector and company-by-company comments on the Q3 results can be found here.