Global Brokerages Flags Indian IT Industry

Barely six months after Goldman Sachs downgraded leading Indian IT companies, US brokerage firm JP Morgan has maintained its underweight stance on the sector, stating that the technology services companies continue to be under an earnings risk. The agency said revenue growth trends have normalized to single digits that was seen when the pandemic struck. 

Goldman Sachs had noted in September last year that the impending economic slowdown had not been factored into the company performances. “We believe a slowdown in discretionary IT services spending around the growth and transformation agenda will be quite material and something not yet completely reflected in the street’s double-digit revenue growth forecast for the industry for FY24,” they said in a report. 

Meanwhile, brokerage firm Bernstein also cut the growth forecast for FY24 by three to four percent and earnings estimates by three to nine percent. They reasoned that the collapse of SVB and other banks had cast a shadow over tech budgets with global IT giants like Accenture and Capgemini lowering growth guidance by 40-50% for calendar year 2023. 

Q4 numbers leaves brokerages huffing and puffing

Coming back to the JP Morgan downgrades, the report said both TCS and Infosys had very disappointing Q4 numbers that brought these concerns to the fore. “Revenues for the largest Indian Techs + Accenture suggests that Covid skewed the tech spend trajectory — pushing it out in CY20/FY21 and brought it forward in CY21-22 / FY22-23. Current trends display tech spend is  reverting,” the report said. 

It further noted that TCS, LTIMindtree, HCL Technologies and Mphasis were most at risk of multiple downgrades while Infosys, Wipro and TechM faced greater earnings risks. “EPS and expectation risk will likely drive near-term stock reaction over PE risk,” JP Morgan said.

Have valuations fallen off their peaks?

From Bernstein’s point of view the valuation multiples have fallen off their peaks and were now in line with or lower than their five-year average over the next 12 months P2E 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, now largely mitigated.” 

JP Morgan also noted that in spite of the recent correction, the NSE IT index was trading 22% above the pre-Covid averages in spite of the fact that growth and margins stayed below the pre-Covid levels. “We believe the worst is not behind yet and Q1 of 2024 could likely be sub-par as the weakness across BFSI, technology, media and telecom in the US could mess things up. 

However, on a positive note, Bernstein expects Infosys to outperform TCS and Tech Mahindra and said 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.