Bottomline: The tech boom is far from over
IT services stocks have taken a beating of late, but a closer look reveals value in pockets and a growth runway.
It isn’t time yet to write the epitaph of IT services companies from an investor’s perspective despite several investment firms underweighting the sector. Far from it. True, several midcaps have had a heady run and valuations have perked-up to levels seen as frothy, but dig deeper and you may be surprised at what you find. The froth isn’t all pervasive. In fact, there’s deep value in pockets that make many such stocks a good bet once this bear phase settles.
A long runway
In a recent conversation, Tata Sons’ Chairman N Chandrasekaran, said he sees AI becoming a very big trend in the future and that he doesn’t see the digital transformation journey losing steam anytime soon. Other industry veterans seem to share his optimism. Chandra’s recent speech at CII highlighted 5 megatrends, of which the first was Digital Adoption. "We can imagine every industry, every business to be a data business… Internet has penetrated the daily lives of everyone and at the same time advances in AI, cloud, and data technology are separating top companies from the rest… No industry can escape this trend," he said. Those are significant statements, and highlight the vast scope of the opportunity.
While several IT services companies have reported a muted fourth quarter, especially on the margin front, most have seen healthy order book additions and the commentary has been very upbeat. HCL Technologies’ C Vijaykumar told CNBC-TV18, “There is so much demand buoyancy, focus is to capture organic demand”. That statement sums up the mood in the industry.
Proven abilities
An important aspect about the top-tier IT services players is that they have proven their ability to transform and realign their businesses to the new market realities. From the body-shopping days and the Y2K opportunity to becoming the digital transformation partners for the world’s best companies, the industry has come a long way. And now, several strides are being made by a motley few like Tata Elxsi, L&T Technology Services and KPIT Technologies in the E-R&D space.
Also Read: Bottomline: Bears can wear you out
For a perspective on what this has translated into, let’s take Tata Consultancy Services, the leader, as an example. Its revenues have grown from under Rs 10,000 crore in 2005 to near Rs 200,000 crore last fiscal. That’s a compounded annual growth (CAGR) of 19 percent. Even over a 10-year period, the growth has been a healthy over 14 percent, and with the digital thrust, this growth perked up last year to near 17 percent. If we look at operating cash flows, the growth has been at a still faster clip. So, with an expected 3-4 year upcycle for the industry, and the top players innovating with new human resource models—internal training & upgrades, hybrid work models and a thrust into tier-2 towns for talent—the leaders should manage to eke out growth and healthy margins.
A receivable aberration?
One interesting development noted in the case of several IT services companies this fiscal was the rise in receivables positions as on March 31, 2022 compared to the previous fiscal. While TCS managed a 3 percent year-on-year growth, despite receivables increasing to about Rs 5000 crore versus Rs 1000 crore a year ago, and Infosys managed some growth most others actually saw their operating cash flows decline, as a result. HCL Technologies, for instance, saw its net operating cash flows dip to Rs 16,900 crore from Rs 19,618 crore a year ago, a decline of about 14 percent, as receivables increased by about Rs 2800 crore compared to a decline of about Rs 750 crore a year ago.
Given the marquee client lists of most tier-1 IT services players, one presumes this is not a recovery issue but a delay and the cash should eventually flow through.
Value in pockets
A sifting through the list of BSE-500 companies reveals that several IT services players are today quoting at quite inexpensive valuations. For instance, even after the dip in operating cash flows in the last fiscal, owing to the receivables issue, HCL Technologies offers an operating cash flow yield of 5.9 percent.
Tech Mahindra is available at a yield of 4.5 percent and even a small player, Zensar Technologies, offers a 4.9 percent yield. Give the expected growth in the industry, these yields will only get better in the coming years and locking into them once the market stabilizes after this bear run can be quite an appetizing prospect.
So, start hunting for value gems in the IT services sector during this downturn. It is best to get in when the sentiment towards a sector is less than positive.
First Published: May 15, 2022 2:33 PM IST
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