Q4 IT service sector summary: Good performance despite headwinds
The Q4 earnings period was good for the Finnish IT services sector despite the headwinds caused by the challenging expert market. Customer demand in the market remained good and the average revenue growth of the companies we followed was 17% (Q3’21: 15%). In particular, organic growth accelerated and averaged 9% (Q3’21: 6%). In the big picture, a bottle neck for growth is still the availability of experts and the high turnover of experts restricts growth, although the Q4 reports, and especially comments given, provided the first concrete signs of the situation alleviating. However, many companies in the industry succeeded quite well in recruitment during Q4. In addition, in practice, all actors utilize subcontracting to facilitate expert availability and increased use of subcontracting partially explains the acceleration of growth. Good employer image and the importance of interesting projects are increasingly important factors in competition on the expert market.
Profitability remained at the level of the previous quarter
The adjusted EBIT margin for the sector was 9% on average in Q4 (Q3’21: 9%). Profitability continued to be depressed by strong competition for experts, with increased levels of employee turnover, wage inflation and rising recruitment costs as side effects. In addition, the increased use of subcontracting and thus the weaker margin structure limited performance to a degree. At company level, strong recruitments also temporarily depress billable utilization and profitability, but due to the earnings logic these moves are essential to secure growth. Compared to the previous quarter, profitability was, on the other hand, supported by a slightly more moderate turnover, although employee turnover was still faster than normal. We expect the turnover to continue to gradually calm down during coming quarters, but we believe, however, that in the big picture turnover will remain above the level seen before the COVID pandemic. Normal turnover prior to the pandemic was about 10%, while during the pandemic it has been close to or sometimes even above 20%. The higher turnover is driven by the increase in telecommuting and thus the decrease in physical presence and more challenging maintenance of a sense of community. Of course, there are many differences between the companies.
Despite headwinds, 2021 was strong in the sector as a whole
As a whole, 2021 can be considered strong considering the hot expert market that created pressure in the form of high turnover and wage inflation. Revenue increased by an average of 18%, of which organic growth accounted for 8% points. Last year, the M&A transaction market was reactivated after the COVID pandemic and all the companies we followed completed one or more transactions. The average adjusted EBIT was 9% in 2021. Revenue growth supported profitability, but as mentioned earlier, wage inflation, increased recruitment costs and high turnover depressed it.
Outlook for 2022 – only small direct Russia effects
Some companies in the sector issued their Q4 report before Russia's attack on Ukraine. However, we believe the direct impact on listed Finnish IT service companies will be very small and in practice only affect Tietoevry (some 2% of the business). In general, however, geopolitical tensions increase the risk level of the industry. Reflecting strong customer demand and the gradually easing turnover problem, the outlook for the industry for 2022 looks good.