ER&D companies: ER&D companies face headwinds in new twist

For the first time in the past 12 quarters, the cumulative headcount at five major pureplay ER&D (engineering, research and development) firms shrank to 77,560 at the end of June, spotlighting the industry’s cyclicality differential with technology outsourcing that’s finally beginning to add jobs – and a dash of much needed colour to pallid placements at engineering schools.

The overall growth of ER&D firms is still higher than IT services companies, but the trajectory of both segments have reversed in the recently concluded quarter.

“Headcount growth has decelerated cumulatively for Indian pure-play ER&D services companies,” Kotak Institutional Equities said in a post-earnings season note. “These companies have focused on better resource utilization and hiring trainees to optimize cost structures over the past year.”

This headcount decline also comes at a time when IT services majors have announced reviving their campus recruitment programs in FY25. The Kotak note disclosed that the cumulative headcount for five ER&D firms – Cyient, KPIT, LTTS, Tata Elxsi and Tata Technologies – fell for the first time in three years in the June quarter. Their aggregate staff base was 78,216 in the March quarter.

Revenue growth at ER&D firms has signalled weakness during their first quarterly earnings. Tata Technologies (services), LTTS (L&T Technology Services), and Cyient (DET) reported revenue declines of 2.5-5% quarter on quarter (QoQ). Even IT major HCLTech’s ER&D segment saw QoQ growth of negative 3.5% in the just concluded quarter. Even the segment’s margin fell by 314 bps QoQ (100 bps is one percent).

Secular Trend Reversal

Pareekh Jain, CEO of EIIRTrend, an engineering insight platform, said, “This is for the first time in three years we are seeing such a broad-based decline in quarter on quarter growth rates in the engineering service space. While LTTS was hit because of the Indian election and therefore its Indian government business was down, Cyient faced some industry specific issues, especially in Telecom. On the other hand, Tata Technologies is facing a client specific issue – one of its largest clients (revenue from Vietnamese client Vinfast is declining).”He added while the engineering services companies have shown sluggish quarter on quarter growth in Q1 compared to IT services, however the weighted average year on year growth of leading Indian ER&D firms is still at 8.2%, almost double than the weighted average of IT services.

Adding reason for the current slowdown, the Kotak note added, while Americas revenue growth has remained sluggish over the past five quarters, some signs of weakness in Europe also emerged such as auto. “Few peers highlighted an abrupt and sharp weakening in demand in the industry, especially in Europe, due to (1) slower-than-anticipated adoption of EVs and (2) rising cost pressures from increasing competition. For instance, Mercedes Benz’s R&D spends declined 7% yoy in 1HCY24”, added analysts at Kotak.

Jain said that in clients specific issues, there were some larger R&D programs which ended recently and new programs are yet to start. “As far as industry specific issues are concerned, they are waiting for interest rate to fall to see the revival of capex and investment cycle.”

Sidhant Rastogi, president, Zinnov, said, “From a vertical perspective, aerospace is the sector where the market is most bullish, and we expect more deals to come in towards the end of the year, sustaining the momentum for at least two years into FY27. On the other hand, telecom is the weakest, and companies with high exposure to this space will need to hedge deals in other verticals.”