IT growth to further slow down in 2023 but these two tech giants may fare better: Nomura

Shares of most IT services companies, including India’s top five Infosys, Wipro, Tata Consultancy Services (TCS), Tech Mahindra and HCL Technologies, were trading in the red on Monday. The downtrend comes alongside unrest in the tech sector, in which many companies are opting for mass layoffs to stave off recessionary fears.

“While tech adoption continues to rise across industries, we expect a slowdown in the next 12 months compared to the past two years of strong spends…Our FY24F revenue estimates are lower than consensus numbers,” brokerage firm Nomura said in its latest report.

Nomura believes there will be a divergence in the operating performance of Indian IT services companies in the next financial year. It added that IT sector valuation has moderated significantly, and its premium to broader Indian markets has fallen in the past six months. However, it remains elevated when compared with long-term averages, and therefore, it is selective in its picks.

The brokerage expects the weakest revenue growth for TCS and the strongest for Infosys in the financial year 2023-2024 among large caps. Its earnings estimates are higher than consensus estimates for Infosys, lower for TCS and Wipro in the large caps space, and higher for Persistent Systems in the mid-caps space, as per its report.

Nomura’s report comes after it refreshed its database of 1,000 relevant listed companies in the G2000 list and found that the calendar year 2023 revenue growth outlook for these companies (based on Bloomberg consensus) has continued to worsen since September 2022.

“Tech budgets are linked to revenue growth of enterprises, indicating a further slowdown in demand in the coming quarters. In particular, BFSI, manufacturing and technology verticals have seen the most decline in the past three months,” it said.

The brokerage explained that for Indian IT services companies, the pain is likely to be more pronounced in interest rate-sensitive sectors like mortgage, capital markets in the BFSI vertical, discretionary retail, and pockets of manufacturing verticals.

Kotak Securities pointed out that BFSI accounts for a meaningful contribution to the total revenue of Indian IT services companies. It highlighted Mphasis earned 54 percent of its revenue from BFS, Wipro earned 35.4 percent, LTI earned 34.2 percent while Infosys earned 30.5 percent revenue from BFSI in the July to September quarter of the fiscal.

“BFS firms continue to talk up technology investments but remain wary of macro. Technology modernization is a key priority and viewed as necessary and strategic. Firms increased technology investment on expectations of healthy RoI (Return on Investment) in the medium term,” Sumit Pokharna, Vice President - Fundamental Research, Kotak Securities told CNBCTV18.com.

In the near term, according to Nomura, furloughs will likely weigh on the sector's growth in the third quarter of the 2022-2023 fiscal. “Overall, we expect USD revenue growth to slow down from 12.7 percent in FY23F to 8.0 percent in FY24F for our coverage universe,” it said.

Nomura said that deal advisors suggest a likely impact of a macro slowdown and continued high inflation in the developed markets on the tech budget outlook for most industries for 2023.

While cost pressures and changing customer preferences continue to increase tech intensity in enterprises’ businesses and could result in higher offshoring work for Indian IT services in the medium term, IT budgets are likely to be prioritised in areas of automation and cost efficiencies in the near term, it noted.

“Easing supply side issues like softening of attrition are likely to lower the back-filling cost of employees. Improving utilisation, as the recently-hired employees are trained and deployed, would be another tailwind,” it said.

Nomura believes that companies with a lower discretionary portfolio (consulting) and exposure to Europe are likely to fare better than the rest. It must be noted that Wipro is a firm with high exposure to consulting, while TCS has high exposure to Europe.

Meanwhile, Kotak Securities has a positive stance on tech investments due to expectations that slowdown/recession will be manageable, indicators such as credit quality, loan growth and consumer spending remain reasonably robust and increase in NII owing to higher interest rates. “The optimistic stance can change with an adverse impact of macro on revenue,” Pokharna, however, said.

According to him, the overall industry growth in BFS tech spends would moderate in FY2024 and divergent performance across IT companies will be seen as it is influenced by 1) exposure to clients cutting spends, 2) vendor consolidation decisions, 3) insourcing by key clients and 4) large/mega deals.

“We have monitored insourcing trends are increasing, with more banks joining the fray. We are bullish on Infosys and HCL Tech and they are our top picks,” he said.