Between January and mid-February this year, the Nifty IT index outperformed the Nifty 500 by nearly 14%, as defensives ruled the roost. But ever since the broad markets started rallying last month, the IT index has given up most of those gains.
Another way to look at it is that it’s a return to ground realities. There was little reason for IT stocks to outperform by a huge margin, given the rising headwinds to the global economy and the related risk to business momentum.
Industry surveys show flagging manufacturing activity in major economies, which in turn has triggered a reset in growth expectations.
Sure, growth rates in the last two quarters have improved, management commentary at investor conferences indicate continuing deal momentum. But sustainability of the acceleration in revenue growth can be tough if the macroeconomic situation continues to deteriorate.
“We do not see acceleration in FY20 for Tier 1 IT and see risk to consensus growth expectations, as Tier 1 IT companies face slowing global growth, structural headwinds of higher exposure to legacy, high competition from challengers, MNCs, Tier 2 IT & insourcing," analysts at Nomura Financial Advisory and Securities (India) Pvt. Ltd said in a note.
An analysis of the client financials by Nomura indicates stability, not a rebound in the banking, financial services and insurance (BFSI) segment. BFSI is a major business vertical for IT companies. Adding to the concerns is the recent appreciation in the Indian currency.
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Rupee depreciation benefits are typically ploughed back into the business through pricing adjustments. Now, with employee utilization levels reaching optimal levels and costs on an increase, a firm rupee can become a profitability headwind unless pricing improves materially. “The impact could get exacerbated by the annual wage-hikes across most players and the visa costs that are typically effective in the first quarter. We see limited headroom in the ‘quick’ levers such as bench management and delivery mix. Thus, a potential margin recovery through 2Q-4QFY19 could be limited," JM Financial Institutional Securities Ltd said in a note.
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The silver lining amid all this is stable demand commentaries from the companies’ managements. Channel checks by JM Financial indicate limited visible impact of the feared macroeconomic slowdown on decision-making or project flows till now, though the broking firm expects deal wins to moderate sequentially in the current quarter. How well the companies manage these challenges will be key for these stocks in 2019.