Bernstein downgrades two Indian IT companies citing risk to growth outlook

Brokerage firm Bernstein has downgraded Wipro and L&T Technology Services post the recent financial sector weakness, which has resulted in stock volatility and risks to its growth outlook for the next financial year.

Bernstein has cut growth forecast for financial year 2024 by 3-4 percent and earnings estimates by 3-9 percent.

The collapse of the Silicon Valley Bank, Signature Bank, and the merger of Credit Suisse with UBS has bought uncertainty bank to banking tech budgets. Commentary from companies on the BFSI sector is starting to become more cautious. As a result of the uncertainty, global IT majors like Accenture and Capgemini reduced their growth guidance by 40-50 percent for calendar year 2023, according to Bernstein.

Financial services is the largest industry vertical for Indian IT services and contributes 15-35 percent of the overall revenue. "Macro headwinds combined with liquidity issues of banks is likely to further soften the tech spending environment," the firm said in its note.

Owing to the highest exposure to the BFSI sector, Bernstein has downgraded Wipro to underperform and cut its price target to Rs 310 from Rs 410 earlier. Wipro has a 35 percent exposure to the BFSI space.

The firm also said that valuation multiples have come off their peaks and are now in line with or lower than their five-year average Next 12 months Price-To-Earnings levels.

"While some investors view valuations still being rich from a 10-year perspective (pre-Covid), we believe the pre-Covid valuation multiples for IT services companies were characterized by structural issues around digital shift & deflationary pressure, which have largely been mitigated," the note said.

Bernstein has also downgraded Engineering Research & Development (ER&D) play like L&T Technology Services to underperform and cut its price target to Rs 3,050. The firm said that growth impact here will be higher due to vendor consolidation, while valuations remain at a premium.

On the positives, Bernstein has an outperform rating on Infosys, which is its top pick within the space, TCS and Tech Mahindra. The firm said that the medium-term cycle remains intact. "Digital transformation led by cloud still remains a multi-year trend and will help sustain a double-digit growth momentum in the medium term," the firm said.

The brokerage expects the margin tailwind to drive the growth in the company's Earnings per Share, compared to revenue growth and that margin expansion in the next financial year should reduce the risk of an EPS downgrade, according to Bernstein.