There is a view by foreign brokerage firm that as recession looms and inflationary pressure is already upon us, companies across the value chain shall curtail their IT spends. While Nomura has downgraded a huge number of IT stocks, it remains optimistic on just 2 namely Tech Mahindra and Infosys. "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," it said.
Nomura's view on correlation between earnings growth and tech spending
"We see a strong correlation between financial performance of the sample set and IT services revenue with a lag of 1-3 quarters (depending on the sector), indicating a potential slowdown for IT services demand in FY24," the report by Nomura said. The observations have been made after study of revenue and earnings profile of some 750 listed companies and stated there can be substantial slowdown in upcoming quarters.
Some margin relief seen for IT company
"We think currency deprecation could be a big wild card in the margin forecast for the sector. While we are building in a USD/INR exchange rate of 77 for FY23F and 78 for FY24F, a sharper depreciation of INR could be a significant tailwind given that every 1% in depreciation yields ~25bp in EBIT margin improvement," they said. Nomura analysts are of the view that easing supply-side issues, enhanced pricing, and a weakening currency may provide some margin relief for IT companies.
Nomura bets on Tech Mahindra, Infosys
Analysts have lowered their FY23-24F EPS by 0-5% for their coverage universe, mainly driven by slowing revenue growth. "In our pessimistic scenario (growth reverting to pre-COVID level) and assuming no margin improvement in FY24F, we see ~16% downside in large caps from current levels," Nomura said. Some of the stocks downgraded include TCS and L&T Infotech for whom the rating has been made to Reduce from the earlier Neutral rating depending on valuations. Further, for Wipro, HCL Technologies, and Persistent rating has been changed from Buy to Neutral, based on the same parameter. Target prices have also been cut by 16-38% by Nomura.
So, the only bullish bets by the company are for Tech Mahindra and Infosys with lowered price targets.'