IT stocks started off the year with a bang, thanks to an absurd belief that 2018 will be a far better year for the industry compared to the previous year. The optimism was exemplified in this brash sector upgrade by Morgan Stanley.
But this belief has fallen away like ninepins, with almost every large IT company failing to report any major acceleration in growth. On the contrary, some large firms are likely to report a deceleration in growth.
Adjusted for the impact of favourable cross-currency movements and acquisitions, Cognizant Technology Solutions Corp. is expected to report a deceleration in growth this year. Hopes that the company will raise the growth guidance it gave three months earlier came to naught, with its mainstay financial services business continuing to struggle for growth.
Cognizant has guided for growth of around 8.4-10%, of which around 70 basis points will be contributed by cross-currency benefits, and in addition, there is a contribution from acquisitions as well. In 2017, it grew revenues by 9.8%.
Ditto with HCL Technologies Ltd and Wipro Ltd, which are expected to report deceleration in growth in this fiscal year on an organic basis. Infosys Ltd might grow at a slightly higher pace, although that is nothing to get excited about.
Only Tata Consultancy Services Ltd stands out, with growth expected to be 2-3 percentage points higher this fiscal year, on the back of some large deal wins. But clearly, it’s foolhardy on the part of investors to have upgraded a whole sector based on the performance of one company. Sure, some mid-sized firms may also report acceleration in growth, although even there, the trend isn’t uniform.
What explains the sluggishness in Cognizant’s growth? As the chart alongside shows, growth in the financial services business has been in the mid single-digits for the past few quarters. Some large banks are increasingly using captive centres for their outsourcing needs. Besides, they are saving dollars on traditional services to reinvest in digital services. Cognizant still gets more than 70% of its revenues from legacy services, and any pressure on that revenue stream will naturally hit overall growth, even though its investments in digital services have helped offset the impact to some extent.
It also remains to be seen what the cost of growth is for companies that end up reporting some acceleration. Infosys, for instance, has guided for a substantial drop in margins, citing its need to invest in growing its capabilities.
Oddly, even though the results season has made it evident that the growth acceleration theory was all hype and no substance, NSE’s Nifty IT Index remains 15% higher than end-2017 levels, outperforming the market by a wide margin. From the looks of it, IT stocks are also benefitting from the so-called TINA factor— there seem to be hardly any decent alternatives at affordable valuations in the Indian markets.