Nifty IT index falls 5% in April; how to play the IT sector after Q4 results?

The Nifty IT index dropped by over 1 per cent on Tuesday, April 30, concluding the month with a nearly 5 per cent loss, following a 7.5 per cent decline in March.

Year-to-date, the Nifty IT index has declined by 6.5 per cent, in contrast to the 4 per cent gain in the equity benchmark Nifty 50.

Looking at a broader timeframe of one year, the Nifty IT index has seen a 20 per cent increase, underperforming the benchmark Nifty 50, which has surged by 25 per cent during the same period.

The Indian IT sector has been struggling for over a year due to weak discretionary demand from clients from the key US and European markets amid elevated interest rates.

The recent March quarter earnings and cautious growth guidance by some of the large IT players have failed to dispel the gloom from the sector.

"Large IT players delivered muted numbers in Q4. They are cautious about the discretionary spending reviving back. The top players expect a slowdown in discretionary spending to continue for a few more quarters before they see some green shoots," CA Vatsal Vinchhi, Equity Analyst - IT sector, Choice Equity Broking, pointed out.

"Companies do have a large deal pipeline consisting of GenAl-led vendor consolidation and cost optimisation deals, but we should wait for a few more quarters before we see discretionary spending coming back and rate cuts happening," said Vinchhi.

Muted Q4 offers little hope

The March quarter numbers of major Indian IT players came mixed. Several firms reported healthy deal wins in the last quarter and improved margins led by increased efficiency and better utilisation. However, their management commentary highlighted the persisting weakness in the demand environment which keeps the outlook for the sector hazy.

Also Read: The good, bad and ugly: Decoding the IT pack’s Q4 show

Deepak Jasani, Head of Retail Research at HDFC Securities, pointed out that after the Q4FY24 results, elevated interest rates, soft recession and weak consumer sentiments in developed economies are the key headwinds for the IT sector. Additionally, greater use of Gen AI is creating a large shift in the industry.

"The revenue growth guidance by some large IT companies has been disappointing. IT companies’ deal wins continued to remain robust. However, converting deal wins into revenue remains the key monitoring point. Fall In subcontracting costs, and better utilisation helped margins, but wage hikes and higher travel costs took away a large portion of this benefit," said Jasani.

Jasani underscored that FY24 was the first time in 20 years that the three leading IT companies reported cumulative headcount decline. He said that with the rise of machine learning, AI, and other new-age technologies, many IT roles like testing, routine coding, and maintenance may be at risk of being automated.

How to play the IT sector after Q4 results?

Experts do not appear optimistic about the Indian IT stocks as they highlight persisting headwinds. They say it cannot be said that the worst is behind for the IT sector as inflation remains sticky, rate cuts may not start anytime soon, and the US economy is showing signs of a slowdown, as shown by the first quarter GDP number, which grew at the slowest pace in two years.

Several experts advise investors should be cautious about IT stocks and choose only large, quality stocks from the sector.

Also Read: TCS vs HCL Tech vs Wipro vs Infosys: Which stock to buy after Q4 results 2024?

Sonam Srivastava, Founder and Fund Manager at Wright Research believes investors must keep an eye on how global economic data, particularly interest rate movements, unfold in the next quarter.

He said if deal wins continue to be strong, and the global situation stabilises, one can consider slowly accumulating shares in select IT companies over the next two quarters.

"Look for companies with strong financials, a diversified client base, and exposure to high-growth areas like cloud computing. Their current valuations might present a good entry point for a long-term investor," said Srivastava.

"If you're risk-averse or have a short-term investment horizon, it might be wise to wait and see how Q4 results play out and how the global market situation evolves. A full picture of the IT sector's health will emerge after the next quarter's earnings reports. You can then make a more informed decision based on the actual performance and future outlook," Srivastava said.

Jasani believes the IT sector could be a tactical play amid subtle signs of a slowdown in the US economy.

"Slowing US GDP growth, postponement of beginning and quantum of rate cuts raise fresh challenges for the sector. Investors seem divided on whether one should bottom fish as the worst may be over or in the price or keep staying away till the dust settles. We think that the bottom may be a couple of quarters away. Till then IT stocks could be tactical plays," said Jasani.

Vinod TP, a research analyst at Geojit Financial Services believes the Indian IT services industry will continue to see moderate revenue growth in the near term on concerns over macroeconomic conditions and inflationary headwinds. However, operating profits are expected to improve with cost optimisation measures.

Also Read: Nifty IT underperforms Nifty 50 in last 1 year; time to take contra bets?

"Our stance remains neutral in the short term but optimistic in the long term for the sector. Given the likelihood of volatility due to concerns over macro headwinds, in the near term, it is advisable to focus on high-quality stocks, particularly those operating in niche areas that can showcase strong revenue growth," said Vinod.

"For long-term investors, adopting an accumulation strategy is recommended. Focusing on companies with strong balance sheets, particularly those involved in AI and Gen AI technologies with strong deal wins, and those de-risking by diversifying across different sectors, could be a better pick," he added.

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