IT Q1 Results Preview - Macro Challenges Persist, Tier-II To Outperform Tier-I: KRChoksey

KRChoksey Research Report

The upcoming Q1 FY24 is expected to be impacted by softness in discretionary spending and client delays in decision-making, which may adversely affect revenue growth. Factors such as project ramp-down and lower conversion to total contract are likely to have a short-term impact on growth.

However, management's commentary indicates a positive outlook, with a strong project pipeline in place. Nonetheless, the conversion process is taking slightly longer, resulting in potentially muted near-term figures for tier-I companies.

On the other hand, tier-II companies are expected to sustain their growth momentum due to a lower base and their ability to provide differentiated services. In this quarter, we anticipate a rebound in spending for sectors such as banking, financial services and insurance, manufacturing, and hi-tech when compared to the previous quarter, Q4 FY23.

Furthermore, we expect the rebound to continue in the subsequent quarters, specifically from the H2 FY24. This growth momentum will be driven by the resurgence of discretionary spending and an acceleration in the adoption of cloud services and generative artificial intelligence within the industry.

Sector Valuation:

Nifty IT has underperformed compared to the Nifty 50 index owing to the worsening macroeconomic scenarios and seasonal furloughs. Companies that provide IT services are noticing a move towards cost-optimisation deals and an increase in vendor consolidation transactions in the works.

We prefer tier-II (mid-cap) players over their tier-I (large-cap) counterparts, given the former’s attractive valuations, increased traction in vendor consolidation, and diversified client portfolios.

The tier-II companies remain best positioned to benefit from long-term structural tailwinds in the sector and should see a relative pick-up in growth, aided by clients’ focus on cost optimisation and efficiencies.

HCL Technologies Ltd. is one of the key beneficiaries of Cloud adoption at scale, given its expertise in infrastructure management services and we expect HCL Tech to deliver strong growth, backed by strong deal wins.

Notwithstanding some short-term discomfort, we continue to be optimistic about the IT services sector, which is underpinned by a healthy medium- to long-term demand outlook.

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