Infosys, TCS, Wipro, TechM, Persistent Systems shares: Up to 40% potential downside ahead for IT stocks

The banking sector woes in the West have turned analysts cautious on IT stocks, as banking and financial services (BFS) clients look to curtail discretionary tech spends in the first half of FY24 in the aftermath of Silvergate, Silicon Valley Bank and Signature Bank bankruptcies in the US and merger of Credit Suisse with UBS in Europe, they warned.

Until now, banking and financial institutions were spending aggressively on cloud migration and tech upgrades, with tech budgets and outlook on tech spending for 2023 being reasonable for most large US banks. But the current predicament for the banking and financial services (BFS) sector in developed markets threw a spanner in the works, said Kotak Institutional Equities. BFSI segment accounts for at least a third of revenues of top IT players.  

"Surviving the current crisis, and ensuring adequate liquidity and capital adequacy will emerge as the top focus, leading to prudence on spending. Tech budgets outlined at the start of the calendar year can be toned down to align with increased risks faced by the sector," it said while suggesting a likely impact on Indian IT growth in 1HFY24.

Nirmal Bang Institutional Equities, which has been keeping a bearish stance on IT sector since April 2022, said buying IT stocks now will give sub-optimal returns going ahead, as it foresees 7-37 per cent potential downside for its IT universe.

Nirmal Bang says its target PE multiples are not pessimistic, as they are still 2-3 times higher than what the IT industry had witnessed during the last major downcycle in 2008-2009 and are at the higher end of the pre-pandemic range.

 

"Buying Tier-1 IT stocks at current valuations (22 times on a 12-month forward basis, 26 per cent premium to the pre-pandemic 5-year mean) will possibly generate at best mid-to-high single digit CAGR total return over the FY25-FY30 timeframe. In fact, on a 12-month forward basis, TCS is trading at 25.4 times and is at +1 SD over the mean on a 15-year basis. If one is aiming for low teen returns from the Tier-1 pack (and very specifically TCS and Infosys), we believe that the entry point must be much lower," Nirmal Bang said.

Nomura India, which hosted top five IT firms namely Infosys, TCS, HCL Tech, Wipro and Tech Mahindra, last week, is cautious on the India IT services sector. The IT companies, it said, highlighted higher macro uncertainties than 3-6 months ago.

While pipelines remain strong, the demand outlook is likely to slow. "Companies remain vigilant about the recent volatility in the global financial system and its potential impact on demand in their BFSI portfolios. Companies expect clients to increase focus on cost optimisation projects (with quicker returns) over long-gestation transformational projects in the near term, with rising macroeconomic volatility," Nomura said.

The foreign brokerage has 'Buy' ratings on Infosys and Tech Mahindra (TechM) in the large cap pack and Persistent Systems and Coforge in the mid-cap pack. The brokerage has 'reduce' ratings on TCS, LTIMindtree and L&T Technology Services.

Nirmal Bang said it agrees with consensus that the IT sector is likely to throw up good cashflows, healthy return ratios, strong return of capital to shareholders and robust corporate governance, what it might be missing would be teen level earnings growth over a sustained timeframe beyond FY25.

Kotak said spending on cost take-outs will pick up, but will yield benefits in H2FY24 or later. The brokerage said TCS and Infosys are better positioned, whereas Wipro and Cognizant Technology are vulnerable. It expects further polarisation of growth between winners and losers in FY2024.

Also read: HDFC AMC stock in focus after SBI Mutual Fund buys 47.33 lakh shares v

Also read: GAIL, HUDCO, Sun TV, NALCO shares to go ex-dividend today; Hind Zinc, SBI Card to consider dividend payout