IT services – Macro worries casting dark cloud on growth prospects

A declining global gross domestic product growth, worsening macro conditions, ongoing banking worries (U.S./Europe banks) and war related uncertainties clearly indicate further risk of slowing down of tech spending by global enterprises.

Moreover, leading indicators for IT companies like delayed onboarding of freshers, flat-to-negative net additions in Q3, moderating large deal wins depicts growth moderation across IT services companies in-line with our core thesis.

With ongoing banking issues, we expect flight to safety in bank deposits in lieu of larger banks over regional ones. This in turn, would lower tech spend opportunities and heat up the competitive landscape at larger banks in U.S. Hence, numerous IT services vendors would chase fewer, albeit larger clients (e.g: top 10 banks in U.S.) with healthy IT budgets. As deal pipeline shrinks, vendors are likely to opt for ‘More (work) for Less’, preferring growth over margins, in near future.

Competitive pressure has risen with leadership changes in tier-I names such as Tech Mahindra Ltd and Cognizant.

Historically, mid-cap grew much slower in pre-Covid period than what is expected over FY23-FY25E, despite strong growth over FY21-FY23. We believe moderation in growth rates for mid-tier names would lead to de-rating of valuation multiples as growth rate differential with large cap narrows down further (premium valuation for mid-tier would wane down and likely to get capped at par to Tata Consultancy Services Ltd.). Bloomberg