Persistent Systems, LTIMindtree, Coforge, Birlasoft: What Macquarie says on these IT stocks

Foreign brokerage Macquarie said 'digital transformation' is a multi-year growth driver for the IT industry, even as clients of some India IT services mid-cap firms have been under pressure already. Macquarie said while consensus worries about growth rates halving, Covid-19 ushered in a new regime in which IT spending will be more resilient, it said. The foreign brokerage thinks that demand for digital transformation has a long growth runway. The basic ingredient to scale up to become a much larger firm is client mining, which is the most important differentiating measure across mid-size firms, Macquarie noted.

"Unlike mammoth IT programs in the old mode of waterfall development that relied on a final Go-Live after years of development and tens or hundreds of millions of dollars spent, digital transformation programs rely on an approach in which a minimum viable product is created in weeks and then improved iteratively with new features added. These programs are deployed almost daily or weekly, reducing the risk of catastrophic failure, making clients amenable to experimenting with new vendors," it said in a note dated January 13.

Macquarie said midcap IT stocks are no more at discount to largecap IT stocks. The level playing field for India IT Services midcaps and their growing capability to successfully play the same role as the large-caps has been rewarded with a PE re-rating in recent years, Macquarie said.

"We think this is well deserved, but think that the valuations should reflect the differences in both growth rates and risks to growth. Our preference is for firms with: 1) proven client mining ability; 2) increasing offshore execution; and 3) declining top-client concentration," the brokerage said while picking Persistent Systems and LTIMindtree as its top picks.

Persistent Systems

Macquarie said Persistent Systems is its top pick as it sees broad-based growth drivers that have helped deliver superior growth despite a drag from top 5 clients.

LTIMindtree

Its second preference is LTIMindtree, which it thinks deserves a re-rating given how the combined entity has much lower business risk vs the individual firms of LTI and Mindtree.

"We see this as a very safe choice and with broader exposure to verticals and the benefit of scale vs

Persistent Systems – which is why we assign LTIMindtree a higher PEG multiple of 2 times against the 1.8 times multiple we assign for Persistent Systems," Macquarie said.

 

Coforge

Macquarie's third preference is Coforge. It does not see Coforge’s high reliance on BFS as a risk as this is a relatively smaller vertical that has been scaled up quickly both organically and inorganically. It  views the BFS contribution positively, as it has diversified Coforge’s vertical portfolio and repositioned it for better growth.

"Furthermore, we view Coforge’s exposure to mid-size US banks, which is one of the fastest growing market segments for India IT Services, as a key positive," Macquarie said.

Birlasoft

Birlasoft is Macquarie's fourth preference. It is a sub-$1 billion market-cap firm. Macquarie said it could surprise with a growth turnaround. Birlasoft has demonstrated a capability to do turnkey outsourcing deals with one deal in the public domain: a large deal signed with Invacare in October 2019, Macquarie said.

"Our channel checks suggest strong domain expertise in Insurance as well for Birlasoft and with a new CEO (Angan Guha) from much bigger peer Wipro, we could see a scale-up in BFSI – which is a core vertical for almost every India IT Services firm that has managed to scale up beyond $1 billion in revenue. We think the demonstrated large deal capability could lead it to win similar deals in the Fortune 1,000 and surprise us positively on growth," it said.
  

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