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Q4FY23 just a sneak peak, banks crisis in US, Europe may impact Indian IT firms’ first quarter of FY24
- For FY24, Kotak said, the estimates for the fiscal were supposed to be weak and should play out that way. The brokerage expects banking crisis in US and Europe to impact Indian IT firms in June 2023 quarter.
Indian tech firms have been trading extremely volatile this week sparkled after TCS and Infosys posted lower-than-expected Q4 earnings. Wednesday was no different, as the majority of IT stocks are in the red with HCL Tech's Q4 earnings in focus. It is expected that TCS and Infosys are not the only ones to see a slowdown in the US performance, others are likely to follow suit in the last quarter of FY23. But that's not all, the banking crisis in US and Europe is expected to even impact the first quarter of FY24.
In its report, Kotal Institutional Equities said, "The slowdown was sharper than expected. Infosys and TCS reported qoq revenue declines of 3.8% and 0.8%, respectively, in North America. The revenue decline in North America was across verticals on a sequential basis. The reasons for the decline were a pause in discretionary programs and even cancellations. After a slow start in January, projects were paused/cancelled in February and it continued in March. The banking crisis in US regional banks and European banks in March 2023 has induced greater caution and could impact the June 2023 quarter."
The brokerage added, "We would not be surprised by a weak US performance across companies that are likely to report in the coming days."
For FY24, Kotak said, the estimates for the fiscal were supposed to be weak and should play out that way. What is critical for valuations is a view on structural growth drivers, i.e., will growth accelerate above the pre-Covid level in FY2025?
Kotak's note explained, "The current slowdown will raise questions about the sustainability of longer-term digital transformation spending. Supporting a constructive view is the fact that workloads on the cloud are still 30-35% and will require additional 2-3 years to reach the desired 60-70% levels."
The brokerage expects the adoption of cloud-native applications to increase as more IT workloads move to the cloud. There are plenty of exciting technologies, such as IoT, big data, and deep learning AI, that lend themselves well to cloud environments. Analytics and big data on the cloud are already seeing massive adoption. These can sustain healthy growth for IT services beyond the cloud migration phase.
In regards to IT companies' margins in FY24, Kotak's note said, "we modelled a margin increase for most Tier 1 in FY2024, noting the easing supply side and levers such as utilization and pyramid that could be flexed. However, we overestimated the flex in FY2024. The current demand environment is not broken, with many large cost take-out deals and continuing programs with near-term RoI. As a result, companies are willing to carry extra costs, including wage increases, so that they do not lose out in case demand picks up. At the same time, clients are pausing discretionary programs."
These factors limit the ability to drive quick improvements in utilization and pyramid.
Coming to recessions, in the past, companies expanded margins. Kotak highlighted that the reason was straight forward—past recessions such as the GFC and Covid had complete clarity of demand destruction.
It said, "Companies, as a result, aligned cost structures rather quickly, something which the current environment does not have. Noting these factors, we now assume margin stability in FY2024 and increase in FY2025."
However, the brokerage does not expect deep recessions in its base case value for Indian IT firms.
Kotak's note added, "We do not assume a deep recession in our valuation base case. Increasing probability of recession does pose risks to multiples. Improved payout ratios of IT companies, full participation in digital journey of clients and legs to medium-term growth from the completion of digital transformation journeys of clients mean that stocks could bottom at multiples higher than earlier recessions, assuming similar cost of equity as in the past. Stock valuations do not bake in a recession but do build in a slowdown."
"TCS and Infosys are best positioned. HCLT and LTIM can benefit in select cases. Similar cost take-out opportunities, but among smaller enterprises may be addressable by a larger pool of companies. Many other companies in the space will struggle—growth between leaders and laggards should widen in FY2024 and beyond," the brokerage's note lastly said.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.
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Business NewsCompaniesNewsQ4FY23 just a sneak peak, banks crisis in US, Europe may impact Indian IT firms’ first quarter of FY24
First Published:19 Apr 2023, 03:18 PM IST
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