Kotak downgrades HCL Tech, Persistent Systems; Infosys remains its top pick; here's what the brokerage firm says

Brokerage Kotak Institutional Equities has downgraded IT players HCL Technologies and Persistent Systems considering the recent rally in these stocks. The brokerage firm believes the recent strong rally limits further upside in select stocks in the IT sector.

HCL Tech share price has gained nearly 11 per cent while Persistent Systems share price has gained over 9 per cent in December so far. The Nifty IT and BSE IT indices have jumped about 8 per cent in December so far.

On the other hand, Infosys remains its top pick among IT services companies under coverage. HCL Tech remains its next pick. Cyient is the preferred pick in mid-tier IT stocks.

Infosys share price has gained over 6 per cent in December so far.

Kotak pointed out that the IT stocks have rallied 7-18 per cent in the past one month, especially during last week.

"While the Fed’s move warranted an upward movement in stock prices, the resulting rally was a tad optimistic, in our view. Our current revenue growth and EPS (earnings per share) estimates already factor in the positives for FY2025—(1) soft landing in the US, and (2) abating of demand headwinds," Kotak said.

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"We increase fair values by 9-20 per cent on rollover and increase in multiples factoring in lower macro uncertainty. The strong rally limits further upside in select stocks. We cut the rating on HCL Tech to an 'add' from a 'buy', following a 13 per cent stock price increase in the past month. We also cut the rating on Persistent to 'reduce' from an 'add'. The stock trades at 33 times FY2026E EPS and is expensive after a 22 per cent rally in the past three months," said Kotak.

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Kotak underscored that IT players saw a significant decline in demand in FY24 due to the reluctance to commit to new programs given high economic uncertainty, reprioritisation of spending away from Covid-era priorities toward efficiencies and optimization, excess in-house hiring, and longer sales and ramp-up cycle in mega deals.

Kotak observed these headwinds resulted in muted revenue growth of 2-5 per cent for large companies and 6-14 per cent for mid-tier names. Revenue declined for Wipro, Tech Mahindra and Mphasis.

Kotak believes these headwinds have bottomed out and will incrementally aid demand and revenue growth in FY25. The brokerage firm said its base case already factors these tailwinds and a soft landing for the US economy.

"The current one-year forward PE (price-to-earnings) multiples are lower but approaching peak one-year forward multiple during FY22. However, forward growth estimates are also considerably lower. Our current FY26E revenue growth estimates for IT companies are 1-4 per cent lower than our FY24E growth estimates two years ago," said Kotak.

"Our estimates bake in a strong June quarter and continued strength in the September quarter as well. This assumes a soft landing, continued momentum in large and mega deal signings and significant recovery in discretionary spending, especially in highly impacted verticals of financial services and hi-tech," said Kotak.

"We note downside risks to June quarter estimates given that enterprise focus on cost reductions will likely continue in the first half of the calendar year 2024 (1HCY24). A growth beat in the second half of the financial year 2025 (2HFY25) is possible in case of a strong pick-up in discretionary spending but will not lead to significant improvement in FY2025E estimates for IT companies, in our view," Kotak said.

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