There has been a massive rerating of IT stocks in the past one year. On an aggregate, IT stocks were trading at 19.6 times one-year forward earnings in end-June, far higher than the multiple of 16.1 times a year earlier, based on the earnings estimates of Kotak Institutional Equities.
Of course, the rerating has been far higher for some companies such as Tata Consultancy Services Ltd (TCS), and Larsen and Toubro Infotech Ltd. So much so that one would imagine IT companies are about to report a huge increase in growth rates vis-à-vis last year.
As it turns out, hardly anyone is expecting this. While growth rates are expected to pick up for a few companies, it’s nowhere near as dramatic as the jump in valuations suggest. Analysts at Nomura estimate tier-I companies to report an 8.7% year-on-year growth in revenues in constant currency terms. This compares with growth of 6.7% in the year-ago period.
Among the top-tier companies, TCS is expected to lead with sequential growth of between 3.5% and 4%. This roughly translates into year-on-year growth of around 9% in constant currency terms, which compares with growth of 6.7% in fiscal year 2018. Another quarter of decent growth would push the company’s growth to double-digits, which will undoubtedly get investors excited.
But it must be said that TCS stands out among large-sized companies. And even in its case, valuations of nearly 24 times one-year forward earnings are pricing in high growth for years to come.
Kotak’s analysts expect companies such as Wipro Ltd and Tech Mahindra Ltd to report a decline in organic revenues, while growth at HCL Technologies Ltd is expected to be sluggish at around 1%. Infosys Ltd was originally expected to grow revenues by around 2.5% in constant currency terms, but a rumour last week has led investors to believe growth would be about 100 basis points lower.
Mid-sized firms such as Mindtree Ltd and L&T Infotech are expected to report decent growth, although valuations of these companies are already at 23 times one-year forward earnings, just shy of TCS’s price-earnings multiple. As such, there is no room for error as far as execution goes. If risks such as client concentration rear their ugly head, investors will be in for rude shocks.
Just ahead of the results season, shares of Hexaware Technologies Ltd rose by 23% and now trade at 28 times one-year forward earnings, or almost an 18% premium to TCS’s valuation. This is either a prime example of irrational exuberance for mid-cap IT stocks or informed insider buying. Hopefully, the June quarter results season will help bring a reality check about expected growth rates in the current fiscal year for IT companies.
