BackIT stocks volatile post Accenture earnings; what should investors do?
The Nifty IT index traded volatile on Friday. Accenture's weak performance and outlook raise concerns about the Indian IT sector. Kotak Institutional Equities expects weakness in discretionary spending and a negative impact on Tech Mahindra and Wipro.
PremiumThe Nifty IT index traded volatile on Friday with the index falling over a per cent in the morning trade and then rising about half a per cent.
Some of the stocks in the index, such as Persistent Systems, Wipro and TCS rose up to a per cent. On the flip side, stocks like LTIMindtree fell almost 3 per cent in morning trade. Around 12:40 am, the Nifty IT index was up 0.32 per cent with 9 stocks in the green and only one stock - LTIMindtree - in the red.
The Nifty IT index fell 2.19 per cent in the previous session. On a weekly scale, the index looks set to extend its losses into the second consecutive week.
On Thursday, the US-based IT services company Accenture reported financial results for the fourth quarter and full fiscal year ended August 31, 2023. The IT giant reported its Q4 revenue numbers within its targeted range but fell short of estimates. The company forecasted the first-quarter revenue below the Wall Street targets signaling that high inflation and interest rate pressures will hurt demand through next year.
Accenture expects first-quarter revenue in the range of $15.85 billion to $16.45 billion, while analysts polled by LSEG forecast $16.43 billion, up 4% year-on-year, Reuters reported.
Read More: Accenture warns of first-quarter revenue below estimates as IT spending remains under pressure
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The read-through for Indian IT players
Experts underscore that Accenture's fourth-quarter performance and Q1FY24 outlook have raised concerns about the Indian IT sector over the near-term demand environment.
"Accenture's management highlighted CMT (communications and media consulting) and North America as the key weak area, which we see as negative for Tech Mahindra (about 40 per cent communications exposure). In our view, Accenture's commentary implies near-term weakness for Indian IT companies," said Motilal Oswal Financial Services.
Kotak Institutional Equities pointed out that Accenture's results and guidance once again highlighted continued weakness in discretionary spending even as enterprises are willing to invest in core modernisation and cloud migration.
Kotak believes Indian IT players with higher exposure to telecom (Tech Mahindra) and consulting (Wipro) will be impacted more.
The brokerage firm underscored that North America continues to be under pressure compared to Europe. Caution on the macro is leading to clients looking for cost savings to fund transformation programs.
"The read-through for Indian IT is negative where discretionary spending remains weak. Cost take-outs are the dominant source of demand," said Kotak.
Timeline for a macro improvement is difficult to predict, said Kotak as it expects the current scenario to continue in the second half of the financial year (2HFY24) and some uptick in discretionary spending in FY25 especially in BFSI and hi-tech verticals.
Kotak forecasts a muted revenue growth of (-)0.6-0.8 per cent for tier-1 IT companies in Q2FY24 which is otherwise a seasonally strong quarter. The brokerage firm expects the sector's EBIT margin to decline marginally YoY, with the quarterly movement influenced by the wage revision cycle. The brokerage firm expects muted revenue growth for mid-tier companies. It also expects strong, and in some cases, record deal TCVs (total contract values) that will set the platform for FY2025E.
Analysts at Axis Securities believe strong investments in digital technologies, cloud transformation, IoT (internet of things), generative AI (artificial intelligence), and machine learning across verticals will support and accelerate companies’ revenue
growth moving forward in the long run. However, the brokerage firm pointed out that the near-term macroeconomic headwinds will
impact automation spending across verticals.
"IT services companies in India are receiving strong deal bookings despite near-term challenges. We remain optimistic about the IT services companies in India over the long term, however, the near-term challenges may impact the earning growth momentum," said Axis Securities.
What should investors do?
Kotak believes Infosys, TCS, HCL Tech and LTI Mindtree are better positioned to address demand among tier-1. Infosys is attractive followed by HCL Tech, it said.
Kotak expects sharp EPS (earnings per share) cuts in Tech Mahindra, moderate ones in others (1-3 per cent) and a negligible cut for Infosys.
"No change in company guidance, except a marginal cut for HCL Tech. We retain a constructive view on Infosys, HCL Tech and Cyient," said Kotak.
Also Read: Fed meeting: Can a hawkish US central bank derail the recovery in the IT stocks?
Brokerage firm Nirmal Bang has an 'underweight' view of the Indian IT services sector as it is explicitly pricing in a shallow recession sometime in 2024.
"Even if one were to ignore the next 12–18 months’ risks around recession and take a five-year view, we believe that starting valuations are expensive and can at best deliver mid to high single-digit total stock returns (including dividends) for TCS/Infosys, as we believe that structural revenue/earnings growth is being overestimated by the street," said Nirmal Bang.
Nirmal Bang said that the dollar revenue growth over a five-year period (FY23-FY28) for tier-1 set in aggregate will at best be at par with the FY15-FY20 period (about 7 per cent) whereas peers believe it will be 300-500bps higher.
The brokerage firm expects margins for most companies to remain in a narrow band at around FY24 levels and not see a material expansion except for Tech Mahindra.
"In our base case of a shallow recession in the US in 2024, we are expecting mid-single-digit dollar revenue growth for tier-1 IT companies in FY25. In our estimates for FY25, we are assuming modest pricing compression while we believe the street is not considering the same," Nirmal Bang said.
"We continue to have a ‘sell’ rating on all IT stocks under our coverage, except Tech Mahindra. Despite having EPS estimates lower than the street in FY25, we suspect it could still see downsides if there is a deep recession in the US," said Nirmal Bang.
Coforge, Persistent Systems and Cyient are Axis Securities' top picks from the mid-cap IT space.
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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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