FTSE 350 Review: Spending boom on IT services

Lots of pandemic changes proved to be temporary. People aren’t shopping online as much as they were in 2021. They are also not playing video games, streaming TV or trading shares in the same quantity. At the time, this wasn’t obvious to investors. 

But one change people are not fatigued with is home-working. In April 2021, 30 per cent of workers said they planned to work mostly from home, with a further 4 per cent expecting to work full-time from home, according to the Office for National Statistics. These figures jumped to 42 per cent and 6 per cent, respectively, by February 2022. That’s a 14 percentage point jump in the number of people who plan to spend the majority of their time away from the office.

In this new professional world, office landlords are obvious losers. Alphabet (US:GOOGL) and Meta (US:META) are planning to ditch their office space in London to save money, according to Financial Times reports, and rents for office space are sliding.  

Scope for more investment

The money saved from these office space cuts is now being reinvested in IT. Ditching physical spaces means companies need to invest in updating their digital capabilities. IT service providers Softcat (SCT), Bytes Technology (BYIT) and Kainos (KNOS) all saw strong top-line growth last year.

In the 12 months to July, Softcat’s revenue increased 37 per cent. Hardware sales jumped 43 per cent, while services increased 31 per cent and software 17 per cent. Hardware outpaced the other sectors due to one big cloud computing contract. Margins slipped slightly because cloud contracts are less profitable, but profit before tax was still up a healthy 14 per cent.

At the time of its results, Softcat’s management told Investors’ Chronicle there was “no evidence of weakening demand”. Since then, a November trading update confirmed customer behaviour was “unchanged from the trend seen in the previous year”. 

It is a similar story at rival Bytes Technology, where revenue increased 28 per cent in the six months to August. Chief executive Neil Murphy is bullish that demand will be robust, and expects future sales growth “at least in the double digits” given the increasing demand for cloud computing. Bytes has Microsoft Azure expert status and in the first quarter of this year Azure revenue grew 42 per cent on a constant currency basis. Being tied to the Microsoft (US:MSFT) wagon isn't a bad place to be, although Azure’s own growth is now slowing.

The real test for IT services will come this year. Such services might sit above marketing and real estate in the hierarchy of costs, but there comes a point when across-the-board cuts need to be made. However, investors should always be thinking long-term, and the pandemic has accelerated the structural tailwinds for the sector. Even if there is a dip in 2023, the ultimate direction of travel is upwards.