Home / Markets / Mark To Market /  For health of IT stocks, watch how BFSI industry performs

Information technology (IT) stocks have been on shaky ground in recent months primarily because of concerns of a US-led recession, which can hurt deal pipelines of companies and eventually revenue growth. Against this backdrop, it is essential to watch how the banking, financial services and insurance (BFSI) industry performs. Analysts estimate this segment to contribute nearly 25-33% of the Indian IT sectors’ revenues.

Growth in BFSI has lagged overall aggregate growth over the past four quarters, according to Ambit Capital’s analysis of sequential constant currency revenue growth of the top four IT companies. With a compounded quarterly growth rate of 3%, it has underperformed segments such as retail, transportation, telecom and media. (See Chart)

Bouts of weakness
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Bouts of weakness

There is a worry that with recession fears lingering and interest rates rising, top global banks may delay their digital spending. Goldman Sachs and Morgan Stanley have recently indicated that they would re-look at spending plans.

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Trends in technology expenditure of major US banks in the June quarter (Q1FY23) indicate a mixed outlook, said Kotak Institutional Equities. Citi’s tech spending trend will be closely watched considering that it is a key account for several Indian IT providers, Kotak said.

“On a sequential basis, revenue from the BFSI vertical remained strong in Q1FY23 for most IT companies, but higher interest rates could weigh on the tech spending outlook of mortgage and lending businesses," said Kumar Rakesh, a senior automobile and technology analyst at BNP Paribas Securities India. Given this, how the macroeconomic situation pans out in the US and Europe in the coming months will be crucial for the sector, he said.

Note that in its Q1FY23 earnings call, the management of Infosys Ltd said, while the overall deal pipeline was strong, it pointed to some softness in its financial services vertical.

BFSI as a percentage of revenues in Q1FY23 was more than 30% each for Infosys, Tata Consultancy Services Ltd (excluding revenues from India, MEA, APAC ex-Australia and products and platforms) and Wipro Ltd. Among mid-tier companies, Mphasis Ltd saw subdued sequential growth in its BFSI segment in the June quarter because of its relatively higher exposure to the mortgage business. Financial services other than mortgages, such as wealth management, have also been impacted by the correction in global equity markets.

“We remain cautious on BFSI growth momentum given that six of eight top US and European banks have indicated similar or lower tech spends with indications of insourcing," said an Ambit Capital report dated 16 August. The research house expects revenue contribution from this segment to moderate in the second half of FY23 as the lagged impact of client financial weakening flows through.

Meanwhile, the Nifty IT index is down 22% year to date, drastically underperforming the Nifty50 index, which has gained 2.3%.

In Q1FY23, some key disappointing factors included lower margins due to wage hikes, increased travel costs, and higher subcontracting expenses. Besides, attrition rates also remained elevated for most IT companies and this is expected to ease only gradually.

“On an FY24 price-to-earnings basis, valuations of both tier-I and tier-II IT stocks have moderated from their recent peaks but are still trading at a premium to their historical average," said Rishi Jhunjhunwala, senior vice-president and lead analyst, technology, institutional equities, at IIFL Securities Ltd. Margins are seen improving as supply-side pressures ease, but demand outlook is key. “However, valuations do not offer much upside from the current levels," he said.

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