TCS To L&T Infotech Shares Fall As Nomura Downgrades India IT Stocks
Infosys and Tech Mahindra are the only buy-rated stocks in Nomura's coverage universe.
Shares of information technology firms fell after Nomura downgraded five stocks in its coverage, citing sooner-than-expected growth slowdown.
The brokerage downgraded Tata Consultancy Services Ltd. and L&T Infotech Ltd. from ‘neutral’ to ‘reduce’; Wipro Ltd., HCL Technologies Ltd. and Persistent Systems Ltd. from ‘buy’ to ‘neutral’ based on valuations, it said in a May 24 note. “Infosys Ltd. and Tech Mahindra Ltd. are the only buy-rated stocks in our coverage universe.” It has also cut target prices for all the stocks in its universe.
“Fast changing macroeconomic conditions, hawkish [U.S.] Fed stance to tame inflation through continued interest rates hikes and profit warnings by corporates across the globe seem to suggest tough days are ahead for tech spending,” Nomura said. “We think enterprises’ willingness to spend on digital transformation will continue, but growth rates on spends are likely to decelerate constrained by revenue and earnings volatility.”
Testing Times
According to Nomura, the ongoing high inflationary environment and tight labour conditions in the developed markets could further intensify the need to outsource. “This, to some extent, should offset the potential hit on discretionary tech spending by the global enterprises in the wake of a weakening and uncertain macroeconomic environment,” it said. “Although we still expect growth rates in the Indian IT sector in FY23F to be strong (double-digit revenue growth), uncertainty on the same continuing in FY24F is extremely high.”
Margin Relief
In the near term (FY23F), Nomura expects headwinds to be higher than the tailwinds for the sector, notwithstanding the recent depreciation of the rupee versus the dollar. “Extremely volatile capital markets and rising interest rates have started to dry up liquidity for startup companies globally. Rising firing of employees (in an endeavour to save capital and demonstrate a path to profitability) and hiring freeze is also likely to slow down the unprecedented demand for tech talent in the coming quarters.”
This, it said, could lead to a material fall in attrition in FY24F, a margin tailwind for the sector. “We also expect the pricing rise discussions to provide margin comfort in FY24F. Overall, we expect EBIT margin of the companies in our coverage universe to fall 30-110 basis points in FY23F, before rising by 10-160 bps in FY24F.”
The research house, however, lowered FY23-24 EPS estimates by 0-5% for its coverage universe due to slowing revenue growth. While Nomura expects the sector to benefit from cloud adoption, it estimates the low penetration levels of public clouds to continue in the medium term.
Other Highlights From Nomura’s Report
A study of revenue and earnings profiles of 750 listed companies globally across sectors suggests a “material slowdown” in the overall financial performance in the upcoming quarters.
It sees a strong correlation between financial performance of the sample set and IT services revenue with a lag of one-three quarters (depending on the sector), indicating a potential slowdown for IT services demand in FY24F.
In its pessimistic scenario (growth reverting to pre-Covid level) and assuming no margin improvement in FY24F, the brokerage sees about 16% downside in large caps from current levels.
HCL Tech’s downside risk: Inability to capture demand from rising cloud adoption, and continued weakness in the Products business.
Infosys’ downside risks: Include weaker-than-expected performance on margins due to supply-side pressures.
L&T Infotech’s upside risks: Continued momentum in deal wins and market share gains. Downside risks: prolonged impact of supply side pressure and Covid-19.
Mphasis’ key risks are weaker-than-expected revenue growth and margins.
Mindtree’s upside risks: continued momentum in deal wins and market share gains. Downside risks: prolonged impact of Covid and higher supply-side pressures.
Persistent Systems’ risks include higher-than-expected deterioration in margin.
TCS’ downside risks include: weaker translation of deal wins into revenue growth. Upside risks include: strong large size deal wins.
Tech Mahindra’s risks include higher-than-expected impact on EBIT margins from attrition and weaker demand environment in the enterprise business.
Wipro’s downside risks include: weaker translation of deal wins into revenue growth and impact of Covid.