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Tide is turning for Indian IT after 2022 trough

A gauge of Indian IT stocks have rebounded after dipping to record lows last year, in a sign that growth may settle above pre-pandemic levels as digital transformation becomes the new normal.

The Nifty IT index of India’s 10 biggest information technology stocks is up 6.87% so far this year. In 2022, it fell 26.04% in the steepest decline since at least 2008 when the barometer shrank 54.56% amid a global financial crisis, according to Bloomberg data. The index more than doubled in the pandemic years of 2020 and 2021, underscoring the rush of digital transformation deals amid stay-at-home restrictions.

The Nasdaq-100, so far this year, has clocked five straight weeks of gains—the longest winning streak since November 2021, when the index peaked. That was despite Big Tech firms disappointing on quarterly results, as investors focused more on cost-cutting efforts the companies are now implementing.

Indian IT firms, too, have seen growth moderate. The top five companies—Tata Consultancy Services Ltd., Infosys Ltd., HCL Technologies Ltd., Wipro Ltd. and Tech Mahindra Ltd.— clocked single-digit topline growth in October-December 2022—a seasonally weak quarter. The commentary, though, was bullish: some of these companies guided for higher revenue growth on the back of healthy deal pipelines and easing attrition rates.

That bullishness reflects in the companies’ price-to-earnings multiples as well. According to Bloomberg data, TCS’ forward P/E is 27.13 as compared to trailing P/E of 31.56—indicating higher earnings potential for India’s IT bellwether. The data is similar for its smaller peers.

  • P/E multiple is a comparison of a company’s market value (price) with its earnings. A higher P/E means the company is overvalued and a lower P/E indicates earnings potential — hence, a good time to invest.

Faith Restored
Separately, Moody’s Investors Service reaffirmed its ratings for Infosys and TCS at Baa1—two notches above India’s sovereign rating of Baa3 stable—with a stable outlook.

The ratings affirmation reflects their positions as the world’s leading IT services providers with globally diversified, cost-competitive operations that translate into sustained, strong profitability and robust credit profiles, Moody’s Senior Vice President Kaustubh Chaubal said, in notes released on Wednesday.

Still, the American ratings agency warned of lag in future revenue growth.

“The revenue growth prospects for IT companies could slow as corporates remain cautious with their discretionary IT budget allocations amid global uncertainties and fears of a looming recession,” Moody’s said, in the note. “But digital transformation trends, along with focus on cost optimisation and streamlining vendors, present an attractive opportunity for leading IT companies [such as Infosys and TCS] that have a wide product suite and capabilities to cater to increasingly complex businesses.”

Key Highlights

  • Moody’s expects 13% increase in Infosys’ revenue in the fiscal ending March 31, 2023, but for growth to moderate to around 8% in FY24. However, higher employee utilisation amid a steady decline in attrition rates will likely arrest margin pressure. EBIT margin will remain at 24% over FY24 and FY25.
  • Moody’s expects 8% increase in TCS’ revenue in the fiscal ending March 31, 2023, but for growth to slow to 5% in FY24 and FY25. However, higher employee utilisation amid a steady decline in attrition rates will likely arrest margin pressure. EBIT margin will remain at 25% over FY24 and FY25.

Contrarian Call
But for some, the exuberance for Indian IT seems unjustified.

“Everyone wants to look at IT as a rotation candidate—these stocks underperformed as much as 30% last year,” Sanjay Mookim, head of research for JPMorgan in India, told BQ Prime’s Niraj Shah, during an interaction on Wednesday. “They are great quality companies [with] no corporate governance issues. So, why not buy IT now?”

The growth isn’t there, that’s why.

“We think that growth will slow,” Mookim of JPMorgan said. “In this downcycle, companies will try to expand margins. JPMorgan’s view is that negative operating leverage can be too hard to handle, and therefore, that margin expansion may not happen.”

The second question is whether this downcycle is here to stay. Mookim is underweight on IT due to slowdown fears and uncertainty on how long it may last.

“If you say that the double-digit growth during the pandemic was a one-off and they are at best good for 8%-9% topline growth now, then that raises the question on valuation multiples,” Mookim said. “Decelerating growth and high valuation multiples do not make this sector attractive enough for us yet.” Bloomberg

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