IT catches COVID-19 bug: Sector’s outlook takes a hit on demand concerns

Information Technology (IT) stocks, which were considered as ‘defensive’ until recently, have been under heavy pressure due to demand concerns caused by the outbreak.

The Nifty IT index has shed close to 20 percent in a month, in line with the Nifty50. The expected earnings pressure, mainly on account of a tepid top line, is weighing on sentiment.

Analysts expect top line pressure to start reflecting from the March quarter itself, given the supply-side disruption amid the lockdown and business disruption in key markets such as the US and Europe. Besides lower billing and utilisation (lower productivity on account of travel restrictions), the disruption will also hit margins, despite a sharp depreciation in the rupee.

The major impact will be felt in H1FY21 (April-September 2020), with demand from clients expected to be sluggish. This will hurt earnings visibility for the entire FY21, given the first half is typically vital for the sector. This is when most of their clients announce their IT budgets.

Therefore, analysts at HDFC Securities have slashed their earnings estimates by up to 12 percent for top IT players, and by a sharper (up to 28 percent) magnitude for mid and small IT companies.

According to Sanjeev Hota, head (research) at Sharekhan: “The rapid spread of the virus has caused disruption in the supply side, and is likely to impact demand in the near term, driven by the cut in discretionary spending by clients, lower billing, and pricing pressure.”

This will impact IT firms’ financial services segment (mainly on account of lower global interest rates) and the retail sector, and consequently take a toll on overall revenue growth, as these two segments contribute 30-45 percent to revenues of most players. Other analysts expect no growth in 2020-21 (FY21).

Besides, deal execution and new deal wins are likely to take further hit, as travel restrictions are expected to continue even after the lockdown. Thus, the revenue growth guidance for FY21 by IT firms is likely to be the lowest in many years.

Recently, Accenture — which follows a July-August accounting period — had cut its 2019-2020 revenue growth guidance sharply to 3-6 percent, from 6-8 percent earlier, due to the impending two-quarter (April-August 2020) coronavirus impact.

Analysts at Phillip Capital say Indian IT companies’ FY21 financials will face double the hit Accenture has.

While the extent of the lockdown is uncertain, analysts expect gradual recovery to start from Q3FY21. However, once the situation normalises, IT spends are likely to see a sharp recovery, with increased demand for Cloud migration, network management, and security, etc.

For now, investors are recommended to wait till clarity emerges on client spending.

―Business Standard