Budget Cuts, Margin Woes May Keep IT Stocks In Narrow Range In Q3, Says Morgan Stanley

Indian IT stocks are expected to trade in a narrow range in the third quarter until further clarity on 2023 IT budgets surface and margin pressures abate, according to Morgan Stanley.

“Initial expectations for 2023 budgets show deceleration across the board,” the investment manager said in its investor note, citing a CIO survey of 100 IT organisations.

IT budget growth in 2022 continued to witness negative revisions with the third-quarter budget growth being reduced by 100 bps sequentially to 3% from 4% in a survey conducted for the second quarter.

IT services budgets also moderated to 2.6% in 2022, making it the fourth consecutive quarter of moderation, the research house said.

The current cycle of downward revisions to IT spending growth, it said, is similar to that of 2008/2009, indicating a potential overhang on the sector.

Morgan Stanley, however, marked the absence of data that could indicate whether the downcycle will be as severe as that seen in 2008/2009, a period when the downward revisions in spending growth continued for multiple quarters before hitting the floor.

Citing the survey, Morgan Stanley said upon first look at 2023 budgets suggest that CIOs, or chief investment officers, expect IT budget growth of 2.8%—below the 10-year pre-Covid average of 4.1%.

The growth in budgets is likely to slow down from 2022 to 2023 across all sectors, it said. Among these, software remains the fastest growing sector at 3.1% compared with 3.7% in 2022, followed by communications at 2.8% from 3.2%.

Growth in spending for services may be at 2.2% compared with 2.6% in 2022 and hardware will likely be 1.5% from 1.7%.

The one-year up-to-down ratio, a metric that measures the ratio of CIOs expecting to revise budgets higher versus lower, declined to 0.4x from 1.1x earlier, indicating that more CIOs expect to lower their budgets in 2022.

Also, 29% of CIOs are more tilted toward discounting compared with 26% in the second quarter ending September. Whereas, 25% of CIOs were less inclined to discount against 33% in the previous quarter.

The Indian IT stocks, which soared during the coronavirus pandemic, have been at the forefront of multiple selloffs over the past year as rising inflation-led monetary tightening by central banks, high attrition, margin pressure, and weaker demand kept investors bearish.