Goldman Sachs analysts downgraded Tata Consultancy Services Ltd., Infosys Ltd. and Tech Mahindra Ltd. citing high valuations that do not factor in the upcoming downcycle.
The investment banking company, however, upgraded its rating on Wipro Ltd. largely on account of "attractive valuations", according to its Sept. 14 report.
During the pandemic, the Indian IT sector has benefitted from three secular tailwinds--outsourcing, offshoring and digitalisation--on the back of accelerated cloud migration. The sector's dollar revenue growth, according to Goldman Sachs, will start to materially slow down hereon given the upcoming macro slowdown.
"We cut our FY24E dollar revenue growth forecast for the top five firms by 4 percentage points to 6% YoY on average versus our earlier forecast of 10%," Goldman analysts Sumeet Jain and Mansi Mittal said in the report.
Shares of India's Top 10 software services providers fell between 5% and 1.9%, led by Infosys and Tech Mahindra, in early trade on Wednesday. The NSE Nifty IT Index dropped the most in nearly three weeks.
In terms of industry verticals and geographies, Goldman Sachs expects a material slowdown in telecom, retail, materials and utilities, with the EU seeing a sharper slowdown than North America.
A slowdown in discretionary IT services spend 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 FY24E.Sumeet Jain and Mansi Mittal, analysts at Goldman Sachs
Stock-Specific Views
Infosys
Forecasts 15.6% constant currencies dollar revenue growth (versus company guidance of 14-16%) for FY23E and just 7.3% in FY24E.
Expects Infosys to deliver weak growth guidance of 6-8% in constant currency terms for FY24E when it reports Q4 FY23 results in April 2024.
Cuts FY23-26E EPS forecasts by up to 6%, and are now 5% below Bloomberg consensus EPS estimates for FY24E.
In our digital capability assessment matrices, we find competition to have caught up with Infosys over the last one year in terms of building competencies and gaining certifications around various hyper-scalers and SaaS platforms.
TCS
TCS is currently trading at an 18% premium to the sector versus the average 12% premium. It seems to be factoring in certain probability of a recession over the next one-two years, given that during such recessionary periods, its premium over the sector has widened to 27% on account of its ability to win large deals around the cost optimisation agenda of its clients.
TCS has the highest exposure to Europe, at 30% of its overall revenues (as of 1QFY22), which is expected to go through a deeper cyclical downturn.
Expects TCS to grow at 6.2% in CC dollar terms in FY24E (vs. 12.3% in FY23E and 15.4% in FY22).
Cuts FY23-26E EPS forecasts by up to 5%, and are now 4% below Bloomberg consensus EPS estimates for FY24E.
Tech Mahindra
Forecast EBIT margin at 12-12.5% versus 14% guidance given by company management as Tech Mahindra will have to invest significantly to build digital capabilities and weak organic growth of 5.7% in CC in FY24E will provide limited operating leverage.
Due to weak organic growth currently assumed by us in FY24E/25E along with lower margin forecast, peg EPS estimate at 13%/11%, below Bloomberg consensus estimates for FY24E/25E.
Amid broader macro slowdown, 5G-related discretionary tech spends could see postponement and also there are limited use cases of 5G currently built globally.
One of the leading demand indicators, order book has weakened over the last two quarters on a YoY basis.
Wipro
Weak organic earnings growth (6% EPS CAGR over FY22-24E) is more than priced-in into current valuations of 16.4X/15.8X FY24E.
Sees a recent pick-up in its order book and strong sequential headcount growth during 1QFY23 as
Two leading demand indicators pointing in a positive direction for near-term growth.
EPS cuts for Wipro are quite modest at 1-3% over FY22-24E.
A potential share buyback announcement over the next 6-12 months could be another positive catalyst for our 'buy' thesis on Wipro.
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