TCS, HCLTech downgraded to "sell" by CLSA who sees further downside to estimates

Brokerage firm CLSA has downgraded Indian IT giants Tata Consultancy Services Ltd. (TCS) and HCL Technologies Ltd. (HCLTech) to "sell" from its earlier rating of "underperform."

Additionally, it has also reiterated its "Sell" recommendation on stocks like Wipro and LTIMindtree.

Despite the downgrade, CLSA has maintained its price target on TCS and HCLTech at ₹3,925 and ₹1,536 apiece respectively.

The brokerage believes that the growth outlook for calendar year 2024 remains weak at best and it is not reflected in the valuations of these companies. The Nifty IT index is up 23% since November 10, 2023 and has outperformed the Nifty 50 by 10 percentage points due to softening of the US bond yields, improving demand commentary by hyper-scalers and the hype around generative Artificial Intelligence and the Nvidia rally.

However, the management of TCS has highlighted on multiple occasions that financial year 2025 will turn out to be a better year compared to the current financial year, which ends on March 31.

Banking, retail, telecom, which are the key verticals for most of the Indian IT companies, their outlook for 2024 is not very different from 2023, according to CLSA. Commentary on similar lines was shared by Tech Mahindra CEO Mohit Joshi, when he spoke to CNBC-TV18 at the Mobile World Congress last week. He said that he remains unsure of when green shoots will emerge for the telecom vertical, which is Tech Mahindra's core business vertical.

CLSA also mentioned that the calendar year 2024 revenue growth guidance of global IT services companies like cognizant Capgemini, Genpact, EPAM and Globant, do not reflect the tailwinds highlighted above, which led to the Nifty IT outperformance.

At the current price, Nifty IT is trading at a 12-month forward valuation of 28 times, which is 1.3 times standard deviation higher than its previous six-year average valuation of 22 times.

Additionally, a mid-single-digit revenue growth guidance by HCLTech and Infosys in April 2024 will be a negative catalyst for TCS, HCLTech and Wipro, according to the brokerage, who sees further downside to its financial year 2025 estimates for these companies.

The Nifty IT index is up 5% so far in 2024 with stocks like Infosys, TCS, Wipro and HCLTech gaining between 6% to 11%.