Brokerage firm Nirmal Bang remains cautious about the IT sector as it emphasises investors use the market rally to pare positions in IT stocks if overweight, especially in the tier-2 set. The brokerage firm has cut the FY25 revenue estimates for almost all its coverage as it expects a shallow US recession in 2024.
"We advocate that investors use the ‘delayed/no landing’ rally seen since October 2022 to pare positions if overweight, especially in the tier-2 set," Nirmal Bang said in a note on September 26.
"We reiterate our ‘sell’ rating on almost our entire IT coverage universe, except Tech Mahindra. We have upgraded Tech Mahindra from a ‘sell’ to an ‘accumulate’ as we feel that margin expansion in FY26 may surprise on the upside under new management. We have tweaked our estimates and target prices from the ones given post-Q1FY24 results. The key change we have made is to cut FY25 revenue estimates for almost all our coverage as we now expect a shallow US recession to be a 2024 event," said Nirmal Bang.
Notably, expectations that the US economy will achieve a soft landing and there will be no recession in the US despite continuous rate hikes by the US Fed have underpinned market sentiment and supported IT stocks significantly. The IT index, along with the broader market indices, has been witnessing a rally driven by the FOMO (fear of missing out) factor. In the last one year, the Nifty 50 has gained about 16 per cent while the Nifty IT index has risen over 21 per cent.
Nirmal Bang pointed out that the Nifty IT index jumped by about 108 per cent from December 31, 2019, till September 19, 2023, while Nifty gained nearly 62 per cent in the same period. This massive outperformance of Nifty IT has been on the back of pandemic-driven digital transformation (DT) services-based earnings acceleration and significant multiple expansions on unprecedented monetary stimulus in the US and Europe.
"Nifty IT has outperformed Nifty by about 630bps YTD (year-to-date) after underperforming by about 3000bps in 2022. We believe the market is taking the view that the worst is over and that revenue/earnings will accelerate sharply in FY25. We have a non-consensus view that FY25 growth is going to be only a tad faster than FY24 with risks that it could be as bad or weaker," said Nirmal Bang.
The brokerage firm highlighted that while the US macro has surprised positively in 2023 so far, deterioration is likely ahead in 2024.
"We have cut FY25 estimates for much of our coverage. Demand is likely to be slower for longer," said the brokerage firm.
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The brokerage firm remains ‘underweight’ on the Indian IT services sector, which has seen PE (price-to-earnings) multiple expansion (especially for tier-2) in the last 6/12 months with no meaningful earnings upgrades.
"Post two successive quarters of weak results (in aggregate), we believe that Q2FY24 and Q3FY24 may see QoQ (quarter-on-quarter) growth for our coverage universe, but the next couple of quarters’ performance will not herald the beginning of a sustained pick-up. We see growth discontinuity in 2024," said Nirmal Bang.
Nirmal Bang said macro uncertainty has accentuated over 2023. The US’ resilience has been driven by consumers and a higher fiscal deficit. The consumer could as a drag in 2024. Europe and China seem to be in a soft patch of their own, the brokerage firm pointed out.
"Over the last 12 months, while order pipeline/inflow has been good, growth has been weak due to weak discretionary spending, weak revenue conversion of TCV (total contract value) won and compression of the existing book of business (with low visibility to the external world). We think the next phase of weakness in 2024 will likely see pipeline/TCV compression with more generalised pricing pressure (unlike the sporadic one currently)," Nirmal Bang said.
Moreover, the brokerage firm pointed out that the downward guidance revisions by multiple players in the last three months imply a weak second half of the year (2H2023) in aggregate.
The brokerage firm believes the next big trigger to be Accenture’s organic growth guidance for FY24 which may be about 1-4 per cent.
Read more on IT sector outlook: TCS, Tech Mahindra, Persistent Systems among top bets as IT stocks surge 22-92% from their 52-week lows
The brokerage firm said it disagrees with the consensus that margins will improve over FY24-FY26.
"The mega deals we believe are fiercely competed (‘priced to win’) and believe are dilutive not only in initial years but are dependent on the extraction of significant productivity gains and operational efficiencies, where companies may fall short," said the brokerage firm.
Disclaimer: The views and recommendations above are those of individual analysts, experts and broking companies, not of Mint. We advise investors to check with certified experts before making any investment decisions.
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