TCS, Wipro, HCL Tech, L&T Tech: JP Morgan downgrades Indian IT sector – Business Standard

has downgraded the Indian information technology sector to ‘underweight’ as it believes the heydays of the sector are over. Rising margin headwinds in the near-term and the revenue headwinds in the medium-term from a potential macro slowdown, Ankur Rudra and Bhavik Mehta of said in the report, will mean that the sector’s earnings upgrade cycle is behind.

“We see peak revenue growth at the rear of us and earnings before interest and taxes (EBIT) margins trending down from inflation, mean revision. While the bottom-up outlook remains for most Services, Software, and SaaS names YTD, and the tech spending cycle remains buoyant structurally, we feel there are more downside risks to the current earnings assumptions. This leads us to downgrade our sector stance to underweight and target multiples by 10 – 20 per cent driving TCS, Wipro, HCL Tech, L& T Technology to underweight from neutral, ” the analysts wrote.

Their top overweight stock in the IT pack are Infosys due to its growth potential, Tech Mahindra for the 5G cycle (telecom) plus margins expansion, MphasiS and Persistent Systems on account of exposure to the defensive industries amid stronger growth outlook.

Thus far in 2022, the Nifty IT has been the worst-performing index, falling around 27 per cent compared to its other peers on the NSE. On Thursday, the index lost around 5. 8 % with MphasiS, L& T Technology Services and Coforge sliding 6 per cent to 7. 2 per cent. Tech Mahindra, TCS, Infosys, and also skidded around 5. 8 per cent each.

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That said, JP Morgan believes that the Indian IT stocks are the most expensive globally and are at a premium to digital native peers and Accenture, and at par with enterprise software that appears unsustainable.

“Sector reverse DCFs suggest that the market is still baking in 6 – 13 per cent development for Tier 1 companies and 14 – 33 per cent for midcaps over the next decade, which seems optimistic, ” Rudra plus Mehta said.

Growth pangs

Growth in the Indian IT sector, JP Morgan said, was accelerating till the third quarter of 2022 (Q3-22) and slowed starting the fourth one fourth of 2022 (Q4-22), which it believes will only worsen in fiscal 2022-23 (FY23) from tougher competition, supply-related issues and a worsening macro situation.

“We expect margin headwinds to drive downgrades in Q1/Q2-FY23 earnings season, and macro-led revenue downgrades in Q3/Q4, that make even current multiples sustainable for some. While USD/INR has depreciated 3 percent in the quarter, adverse forex have nullified any margin gains. With growth slowing down to just ahead of pre-Covid levels, our new multiples are anchored around +0. 5 standard deviation (SD) to -1 (SD) of three-year average price-earnings (PE), ” the JP Morgan analysts wrote.

Those at Kotak Institutional Equities, too, remain cautious and suggest the particular recent correction in the field has been mostly driven simply by three factors— increase in interest rates, fears of recession in key client geographies and the risk to margins. “What is priced into stock is risk to margins. What is not priced in is economic recession, ” Kawaljeet Saluja and Sathishkumar S of Kotak Institutional Equities in a recent note.

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