India's infotech stocks, one of the most shunned corners of Dalal Street by institutional investors, will be under the spotlight this month as IT services giant Tata Consultancy Services (TCS) kickstarts the first quarter (Q1FY24) earnings season by declaring its results on July 12 — followed by Infosys, Wipro, Tech Mahindra, HCL Technologies, among others.
After a forgettable performance in the last quarter of the previous fiscal, domestic
IT companies are bracing for more uncertainty in the near term, thanks to the banking turmoil in the US and fears of an impending recession.
Weak quarter, healthy deal wins
June is a seasonally a strong quarter for IT companies. However, June 2023 will be an exception, with revenue declining for certain companies (Wipro and Tech Mahindra), flat for
TCS and marginally growing for some (HCLT at 1 percent and Infosys at 1 percent quarter-on-quarter).
"We believe revenue growth year-on-year will move to low-single digits to high-single digits. Weak discretionary spending across many verticals, and especially in financial services, telecom and hi-tech, should contribute to weak trends. Dollar growth quarter-on-quarter will be aided by a cross-currency tailwind of 13-42 basis points," said analysts at Kotak Institutional Equities.
A soft discretionary spending environment, combined with the pullback of projects in financial services and telecom, will drive a sequential revenue decline to marginal growth for tier 1 IT companies in a seasonally strong quarter, Kotak said.
A pickup in cost takeout and consolidation deals will result in robust deal wins for a few large IT companies.
Kotak believes
Infosys will report the highest sequential growth among the tier 1 companies. Also, as per the brokerage, companies that will report revenue declines include Tech Mahindra, Wipro and Mphasis.
Analysts at ICICI Securities said that signs of revival is likely to be apparent only in the second half of FY24. "We believe the June quarter may be softer than the current consensus expectations based on our discussion with IT companies and Accenture’s August quarter guidance. At the same time, positive demand indicators point towards a resilient tech spend demand over medium-to-long term," it said.
EBIT margins may remain flat in FY24
EBIT (earnings before interest and taxes) margins, which is used to indicate a company's profitability, are likely to remain flat in FY24E as benefits from cooling-off attrition and improving utilisation are expected to be offset by higher pricing pressure, increase in travel costs and no incremental benefits from pyramid optimisation.
Meanwhile, ICICI Securities believes that valuations for the Indian IT sector are still not attractive and there is scope for further downside due to weak earnings growth in the next 1-2 quarters. However, it said multiples could sustain in the medium term given strong structural demand tailwinds around cloud migration and digitalisation.
"We assume pick-up in growth in H2FY24 and assign last 5-year average multiple to companies in our coverage universe, which was the beginning of cloud and digitalisation cycle for Indian IT companies," the note stated.
In the existing scenario, ICICI Securities continues to believe stock price returns may be driven by earnings growth rather than multiple expansion.
However, the brokerage remains optimistic on the prospects of Infosys, Persistent Systems and Tata Consultancy Services (TCS) and has recommended a 'buy,' while upgrading HCL Technologies to 'add.' It has downgraded LTIMindtree, Happiest Minds and Tech Mahindra.
What analysts recommend on IT stocks
Stock name | Rating | Target price |
Infosys | BUY | Rs 1,641 |
TCS | BUY | Rs 3,786 |
Persistent | BUY | Rs 5,960 |
HCL Tech | ADD | Rs 1,291 |
LTIMindtree | ADD | Rs 5,637 |
Happiest Minds | ADD | Rs 1,038 |
Mphasis | HOLD | Rs 1,812 |
Wipro | REDUCE | Rs 350 |
Tech Mahindra | SELL | Rs 927 |
Downside risks include, as per ICICI Securities:
Any potential negative impact of cenerative AI on contract pricing and margins, which is still unknown.
Delayed macro recovery and tech spending outlook due to persistent high inflation and interest rates.
Pricing pressure and margin dilution due to higher focus on cost optimisation deals where competition is stiff.(Edited by : Shoma Bhattacharjee)
First Published: Jul 3, 2023 10:34 AM IST