Indian IT Stares At Near Washout In FY24, Says JPMorgan
JPMorgan reiterates its negative view across the IT services universe, with the last neutral rating downgraded to underweight.
India's $245-million IT services industry is staring at a longer-than-expected slowdown, even a complete washout, in financial year 2024 as deal-making deteriorates, according to JPMorgan Chase and Co.
Project deferrals and cancellations likely persisted in April–June without clear signs of a bottom, JPMorgan said in a research report on Wednesday, after meeting 15 industry participants in Bengaluru. Increased competition for a shrinking deal-making pie is likely to trigger falling win and rates, pricing and deteriorating deal terms, it said.
The products and platforms, digital transformation and engineering R&D segments of IT services firms are seen as most impacted by the decline in discretionary spending, but the legacy-managed services are likely to hold their own.
In the quarter ended March 31, the IT services industry clocked its worst performance since the beginning of the coronavirus pandemic as the spectre of a slowdown—stemming from a banking crisis in the US and a prolonged war in Europe—roiled deal-making in financial services to telecom and retail. Software services firms have turned cautious on the demand environment as the concerns of a recession in the US weighed on the discretionary spending.
While bookings are still supported by cost takeout and efficiency deals, revenue growth is impacted by project deferrals, delayed ramp-ups and cancellations. The outsourcers are even more wary of the pricing environment.
Management commentary has indicated that the first half of fiscal 2024 is likely to be a washout. Growth is unlikely to return in a hurry, at least not until the geopolitical headwinds ease in the second half of the fiscal.
That, too, may not happen now.
"We feel that current expectations of a quick or a V-shaped recovery are likely to prove optimistic and could be unlikely over the next six-nine months," JPMorgan analysts Ankur Rudra and Bhavik Mehta said in the report. "This suggests that all of CY23/FY24 could be a washout as opposed to just H1CY23 as currently perceived."
The brokerage estimates the IT sector to grow at less than 5% in the current fiscal as against the 4–7% growth that was predicted after the March-quarter results.
"We reiterate our negative view across the IT services universe, with our last neutral rating downgraded to underweight," JPMorgan said. "We expect every IT services firm to disappoint in Q1 and current H2 FY24 growth expectations."
On India's Top 5 IT Services Firms
Tata Consultancy Services Ltd. (Rating: Underweight; Target Price: Rs 2,700)
Investment Thesis: We remain underweight on the stock as we bake in lower growth from macro concerns in FY24E that will also limit significant margin expansion. The unexpected CEO departure could lead to periods of volatility in a time of weaker tech spend and rapidly evolving macro.
Valuation: Our March 2024 price target of Rs 2,700 is based on 20x one-year forward P/E, which is -1.5SD of its three-year average. We believe the multiple is justified by slowing revenue growth and risks to both revenues and margins from a potential macro slowdown.
Infosys Ltd. (Rating: Underweight; Target Price: Rs 1,550)
Investment thesis: Our UW thesis is driven by three main factors:
Lower growth expectations in FY24 of 3% constant-currency terms year-on-year below the lower end of the IT firm's guidance of 4–7% as we believe H1 FY24 will be weak, given the uncertain macro, and H2 FY24 won't be able to carry the burden of lifting full-year growth.
Weak leading indicators in the forms of declining net new large deal total contract value and a sharp slowdown in hiring, suggesting weaker growth ahead.
Infosys' loss of growth leadership to TCS in Q4 FY23, while slipping margins are not yielding a growth advantage.
Valuation: Our March 2024 price target of Rs 1,150 is based on 18.5x one-year forward P/E, which is -1.5SD of its three-year average. This is a premium to scale service providers, except TCS, which we believe is justified by high structural margins, high sustained payouts and stronger competitive positioning.
HCL Technologies Ltd. (Rating: Underweight; Price Target: Rs 900)
Investment thesis: We believe HCL Tech's P&P diversification has complicated its equity story and diluted organisation-wide performance management. It has likely driven underinvestment in digital (lowest among peers) and masked margin dilution in its core IT services business. We see it as a source of avoidable drain on capital allocation and management resources when the core IT services industry growth is at a multi-decade high.
Valuation: Our March 2024 price target of Rs 900 is based on a sum of the parts valuation methodology, with a 15x one-year forward P/E multiple assigned to its services business and a 5x one-year forward EV/Ebitda multiple to its P&P business. We believe our IT multiple (25% discount to Infosys/TCS target multiples) at -1SD of its three-year average is justified by slower growth expectations. Our P&P multiple (50% discount to global peers) is justified by a chequered track record and lack of proof of sustained organic growth.
Wipro Ltd. (Rating: Underweight; Price Target Price: Rs 360)
Investment thesis: Wipro's weak Q1 FY24 guidance highlights the challenging macro environment that will lead to a sharp slowdown in growth in FY24E and keep it under pressure in the absence of operating leverage, in our view. Wipro's higher consulting exposure keeps it at a higher risk of slowdown than peers. Maintain UW.
Valuation: Our March 2024 price target of Rs 360 is based on a 15x one-year forward P/E, at -1SD of its three-year average. The 15x multiple is at a 25% discount to our target multiple for Infosys. We believe this is justified by lower revenue growth expectations over FY24/25 relative to Infosys.
Tech Mahindra Ltd. (Rating: Underweight; Target Price: Rs 950)
Investment thesis: We are underweight on Tech Mahindra due to the weakness seen in its portfolio from the uncertain macro that drove down large deal TCV sharply in Q4 FY23, which we believe will lead to a sharp deceleration in growth in FY24 and thereby pose margin challenges.
Valuation: Our March 2024 price target of Rs 950 is based on 15x one-year forward P/E, 1SD below its three-year trading average.
