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The country’s top IT companies are seeing way faster growth from manufacturing and engineering clients than from banks in recent times, and industry experts say much of this underlying growth is coming from automotive firms.

The experts said automotive companies are increasingly reaching out to IT firms as they do not own the software knowhow needed for their biggest transformation in a century, from conventional vehicles to electric vehicles and self-driven, or autonomous, vehicles.

Three analysts Mint spoke with said the contribution of automotive firms to revenue from manufacturing or engineering, research and development (ER&D) services of IT companies is now 25-35% compared to 15-20% four years ago. (IT companies do not divulge automotive numbers separately, apart from clubbing them under manufacturing or ER&D heads.)

Automotive clients comprise at least 10% of the global ER&D market, which is worth $1.8 trillion, said Kumar Rakesh, India analyst for IT and automotive sectors at financial services firm, BNP Paribas.

Of course, banks, including JP Morgan Chase & Co, Citi and Lloyds Bank, which have been Indian IT’s biggest clients for over a quarter of a century, continue to bring in the biggest chunk of revenues.

Automotive business shifts to a higher gear

All three analysts agreed that Infosys Ltd leads the pack, with automotive clients contributing an estimated 35% of its manufacturing revenue in recent times. HCL Technologies Ltd and Tata Consultancy Services Ltd (TCS) are estimated to each draw 30% of their ER&D and manufacturing revenue from auto firms.

A look at data shows the pace of growth of manufacturing and ER&D business is much higher compared to overall revenue growth for Infosys and HCL, albeit not for TCS.

Infosys’s revenue from manufacturing more than doubled from $322 million in the fourth quarter of FY20 to $670 million in the latest January-March period. Comparatively, its annual consolidated revenue grew 45% to $18.56 billion in these four years. Also in this period, manufacturing’s share of overall revenue rose from 10.1% to 14.7% for the Bengaluru-headquartered company, while that of banking shrank from 31.3% to 26.4%.

HCL Technologies, which drew over 16% of its net revenue from ER&D services in Q3FY24 (the share has remained constant since FY20), earned $559 million from this segment in the December 2023 quarter, up 72% over $325 million earned in Q3FY20. Banking’s share of its revenue has also remained constant since FY20 at 21%.

HCL is expected to announce its FY24 results on Friday, 26 April, but a Bloomberg estimate of 39 analysts expect its FY24 revenue to be $13.2 billion, thus, potentially marking a 33% growth in four years. That would be less than half the pace at which its ER&D revenues have grown.

The analysts cited above estimate that Infosys’s latest quarterly revenue from automotive clients would be around $235 million or 5.2% of its net quarterly revenue.

For HCL, estimated automotive revenue for the December quarter was $170 million, which, too, is around 5% of its quarterly revenue. For TCS, automotive revenue as of the March quarter was around $195 million—around 2.5% of its net quarterly revenue.

TCS and Infosys did not immediately respond to emails about their automotive clientele. HCL Technologies declined to comment, citing a silent period ahead of its earnings on Friday.

The M&A push

A lot of growth in automotive businesses can be attributed to acquisitions and mega deals that the large-cap IT firms have signed. Last week, Infosys made its biggest acquisition when it agreed to spend $480 million to buy In-Tech, a German automotive ER&D firm. In-Tech reported $180 million in revenue last year.

Significantly, Infosys’s acquisition of In-Tech comes three years after the company bagged an over $3-billion deal, its biggest, for eight years from German car maker Daimler AG in December 2020.

Noida-headquartered HCL Technologies spent $260 million last year to buy ASAP Group, a German automotive engineering services company. HCL in January had guided to grow between 5% and 5.5% in constant currency terms, implying its growth would be more than TCS and Infosys, which grew 3.4% and 1.4%, respectively, in constant currency terms.

HCL also managed to clock the fastest growth back in 2020. At the heart of its impressive performance has been its acquisitions and its bet on the ER&D space, which the numbers clearly reflect, too.

The automotive boost for Indian IT

Industry reports and analysts project automotive to be a strong contributor to the near-term growth of IT services firms. On 16 February, industry body Nasscom said in its Annual Strategic Review, 2024 that ER&D will be the fastest-growing vertical for the industry in FY24, growing at 7.4% year-on-year (y-o-y), as against the net industry revenue growth of 3.8% y-o-y.

“With digital imperatives and the resurgence of AI, ER&D maintains its concentration on digital engineering. Domains like aerospace and software-defined vehicles, autonomous driving, and digital connected solutions are driving growth,” the report said.

“Globally, 5-6% of all ER&D operations by automotive firms are outsourced, and a further 4-5% is done through joint ventures in global capability centres (GCCs) that have come up majorly in India,” said Apurva Prasad, vice-president of institutional research at brokerage firm HDFC Securities.

“This is largely due to the sensitivity of intellectual property that automotive firms own. However, most automotive firms do not have the kind of software capabilities that are needed for reinventing the wheel, which electrification of vehicles (EVs) and SDVs necessitate,” Prasad said.

BNP’s Rakesh added that manufacturing companies had under-invested in technology so far.

“Covid-19 pandemic lockdowns pushed automotive companies to a just-in-time manufacturing model. This needed technology investments for supply chain modernization. Automotive companies are also going through a once-in-a-century disruption in order to invest in EVs,” he said. “This transition of entire portfolios is causing an elevated level of tech spending across the industry. While this is happening, many automotive firms are struggling to ramp up their tech workforces in-house.”

Prasad further pointed out that smaller IT services firms, which are not as broad-based as their larger peers, have focused strategically on the automotive engineering sector to continue to grow in revenue in FY24.

The mid-cap IT uplift from auto

Pure-play automotive engineering firm KPIT Technologies earned $428 million in net revenue between April and December last year. This is a 46% y-o-y growth for the nine-month period between FY24 and FY23—and is already higher than the full-year revenue of $418 million that the company earned in FY23.

Three experts who closely watch the sector said that KPIT Technologies is likely to grow at an organic growth pace of over 25% this year, and nearly 40% including acquisitions it made this year.

“Strong growth posted in the past two fiscals by mid-cap companies with a clear focus on automotive engineering clearly reflects how the automotive ER&D vertical is a strong growth avenue in the near-term,” Prasad said.

Fellow mid-cap automotive-focused IT service provider, Tata Technologies, reported $461 million in nine-month revenue until December for FY24. In comparison, the company earned around $256 million (revenue converted from ₹2,112 crore in rupee revenue) in FY23—leaving it with potentially more than double its previous-year revenue in FY24. For reference, 86% of Tata Technologies’ revenue comes from automotive operations in FY24 compared to 89% in FY23.

This is fuelling the growth, which has the potential to be a strong contributor in the near-term.

“The automotive R&D market size is pretty big, which means that companies have a fairly sizeable market to target,” HDFC’s Prasad said. “However, EV growth slowed down this year, which led to a slower-than-expected growth in automotive manufacturing operations for IT services firms in India. In the near-term at least, this should be resilient.”

Not without challenges

Paribas’s Rakesh added that while the HSBC purchasing managers’ index (PMI) figures for manufacturing—an indicator that denotes spending in overall operations within the industry—have shrunk for numerous geographies and industries, automotive spending has remained resilient, and even grown.

This is yet another key indicator that, at least in the near-term, IT service providers with a clear focus on automotive ER&D could stand to gain.

However, there are challenges. Analysts state that BFSI is a far stronger and more perpetual sector that will always need tech adoption, but the same may not reflect for auto firms.

A senior industry consultant, who works closely with the top IT firms, said on condition of anonymity, “R&D spending by auto firms will be driven in the near-term due to the need for new vehicle platforms, but will likely slow down based on industry demand.”

There is, therefore, no substituting BFSI, without which the sector could continue to struggle beyond a point.

“BFSI is a very strategic vertical for the IT services industry. While there is cyclical weakness right now, I don’t think any IT services company would be looking to reduce their focus on this vertical,” said Rakesh. “We’ve definitely seen a reduction of around 100-150bps in the weight of the sector, but this is largely due to a cyclical weakness of this industry.”